The Bank of Canada kept its key overnight rate steady at 5% on Wednesday as expected and said it was still too early to consider a cut, given the persistence of underlying inflation.
The news helped pushed the Canadian dollar up 0.4% to 1.3540 per U.S. dollar, or 73.86 U.S. cents, as the bank’s commentary was perceived to be a little more hawkish than some traders were positioned for.
Canadian bond yields held relatively steady following the announcement, but yields drifted higher during Governor Tiff Macklem’s press conference. In early afternoon trading, Canada’s two-year yield - which is sensitive to policy moves - was up 5 basis points to 4.10%, even as the equivalent U.S. Treasury yield was modestly lower. It was a similar case across much of the bond curve.
The moves came as money markets modestly trimmed back their bets on the first Bank of Canada interest rate cut arriving in June and sliced the odds of a cut arriving at the bank’s next policy meeting in April in half. A rate cut is fully priced into the market by the bank’s July meeting.
The following table details how swaps markets are pricing in further moves in the Bank of Canada overnight rate, according to Refinitiv Eikon data as of 1035 am Friday. The current Bank of Canada overnight rate is 5%. While the bank moves in quarter point increments, credit market implied rates fluctuate more fluidly and are constantly changing. Columns to the right are percentage probabilities of future rate moves.
And here’s how markets were pricing in monetary policy changes late Tuesday:
Most economists are also expecting the first BoC cut to arrive in either June or July. Here’s how they are reacting:
Benjamin Reitzes, managing director, Canadian rates and macro strategist, BMO Capital Markets
The tone of the policy statement and press conference opening statement was balanced, but not as dovish as the market was anticipating, with the Canadian dollar rallying in the immediate aftermath.
Inflation remains the key for policymakers who clearly aren’t comfortable yet. The statement highlighted that “underlying inflation pressures persist” and core inflation remains in the 3%-to-3.5% range. In addition, the share of components above 3% is above the historical average, despite trending lower. “The Bank continues to expect inflation to remain close to 3% during the first half of this year before gradually easing.” If inflation evolves as expected, that suggests we could see a mid-year start to cuts. At this point, the BoC looks comfortable holding rates steady through the spring, as there’s still a fair amount of wood to chop on inflation.
On the economy, Q4′s better-than-expected GDP growth was noted, but “the pace remains weak and below potential”. Anticipated ongoing softness in growth, and the economy operating “in modest excess supply” is expected to help drive disinflationary pressure and open the door to easing later this year. Also, moderating employment growth was cited, as “the labour market has come into better balance”. One small win for the doves out there is that wage pressures “may be easing”... hardly definitive, but it’s the right direction.
The last paragraph was almost a carbon copy from the January statement, suggesting a very high bar for an April move. This quote from the press conference opening statement sums it up well: “We’ve come a long way in our fight against high inflation. Monetary policy is working—inflation is coming down. But it’s too early to loosen the restrictive policy that has gotten us this far.”
Key Takeaway: There’s been good progress on inflation, but with core CPI still rising at an above-3% pace, the Bank remains concerned about upside risks. BMO continues to look for a June start to cuts, and there’s nothing in today’s statement to change that view.
Avery Shenfeld, managing director and chief economist with CIBC Economics
Those frustrated by the Bank of Canada’s unwillingness to even talk about cutting rates in today’s policy statement should bear in mind what its message is designed to do. When rates are left on hold, and so many Canadians are hoping for easier borrowing costs, the Bank needs to focus its words on why it isn’t cutting just yet, not on what it might do down the road. Having too many nods in today’s message about the progress on inflation, or to downside risks to growth, would only have raised more questions about its choice to keep the policy rate at 5%. As a result, we should be careful about drawing too many conclusions about rate cuts ahead from the lack of any clear steps in that direction in its official statement. Instead, we can simply conclude that today was judged as too soon to make a move.
Its statement gave a nod to some signs that wage pressures are easing, but balanced that by saying growth was a bit better than expected, if still weak. On inflation, while it mentioned that the overall pace had slowed, it judged that that underlying inflation pressures still persist, led by shelter, and maintained its message that it’s is still “concerned” about that persistence, and wants to see more progress. In the statement, it opted to stick to its two preferred core inflation measures, with no mention of the better progress seen in measures like CPIX that strip out mortgage interest costs. But it also highlighted the percentage of items that are rising above 3%, and in the press conference, the Governor indicated that they don’t only look at the two official core measures, but also a “whole range of indicators.”
We know from remarks the Governor made elsewhere that he judges high rates as not the best tool to address shelter inflation, and the Bank is certainly aware that rate cuts would ease the mortgage interest component of shelter. Government steps to slow inflows of students could help on the rent side. That suggests that continued moderation in inflation rates for other parts of the CPI basket, and a greater share of components below 3%, could be sufficient to have the Bank easing at some point this year, even if headline inflation is still elevated by shelter. ...
The Bank is expecting to see inflation start to dip below 3% during that latter half of the year. Wage inflation has been a concern for the Bank, so its decision to mention of some signs of moderation on that front is of some importance. Unfortunately, the data have been inconsistent. Data from the SEPH (payrolls) survey showed a marked deceleration in pay rates in the past six months, but today’s productivity report still had overall compensation in the 4 1/2% range year-on-year, lifted by brisk gains for the non-business (i.e. public) sector.
It wouldn’t be the Bank’s style to hint today about a rate cut as far off as June, so we’ll stick with our call for a rate cut that month despite the lack of fresh dovish talk today.
James Orlando, director and senior economist, TD Economics
The song remains the same. The BoC came out today to reinforce its view that more time is needed to make sure that inflation is headed to the 2% target. We get it. With core rates of inflation tracking around the mid-3% level, the Bank can justify waiting longer. Luckily the central bank has been gifted a little more time to wait. Economic growth eked out small, but positive, growth to end 2023. With effectively no pressure for the BoC to respond, it can sit back and wait for a couple more inflation reports to roll in.
Markets don’t think the BoC can get too comfortable. ... While the BoC isn’t ready to adjust course just yet, we think that the time for rate cuts is quickly approaching.
Shaun Osborne, managing director, chief currency strategist., Scotiabank
Running into today’s meeting, no-one realistically expected the Bank to ease policy. But there was some anticipation in some quarters that policymakers could lay the groundwork for rate cuts by mid-year, or even before, a bit more clearly. The April OIS [Overnight Index Swaps] contract priced in a little less than 50% probability of a rate cut before today’s decision.
The policy statement was a fair bit shorter than January’s but noted slightly stronger than expected growth in Q4 (helped by exports), even if the pace remains weak and below potential. It said that there may be some signs that wage pressures are easing. On prices, the Bank noted the decline in January inflation but underlying price growth—and the breadth of price rises—remains elevated. The statement retains the final paragraph largely unamended. This states that Governing Council is “still concerned about the risks to the outlook for inflation, particularly the persistence of underlying inflation”. It is very hard—as in virtually impossible—to see those concerns alleviated sufficiently by April for the Bank to cut rates. A summertime start to the easing cycle remains most likely. April OIS pricing has eased a bit around the policy decision but still reflects a bit less than 30% chance of a cut. Further repricing (to zero) of April rate cut risks may give the CAD some additional lift in the short run.
The potential for a significant rebound in the CAD remains limited, however, with USDCAD trading close to—my estimate of— fundamental fair value this week. But that also implies limited scope for the CAD to ease. While the CAD has perked up a bit around the Bank of Canada decision, some of that movement reflects a general softening in the USD. External drivers—more general weakness in a still relatively rich-looking USD overall, for example—remain the best chance of juicing up CAD gains in the short run. Recall that seasonal factors do turn more CAD-positive in late March and into Q2/Q3, however. Scotia’s 1.33 end Q1 forecast remains reachable and USD gains to or through 1.36 still look to offer reasonable value for USD sellers for now.
Royce Mendes, managing director and head of macro strategy, Desjardins Securities
Canadian central bankers held rates steady, but have seemingly all but ruled out further rate increases. While policymakers say it’s still too early to consider lowering rates, Governor Macklem acknowledged that policy is working as expected. The economy remains weak and inflation has eased further since the January rate decision. In the communications released today, officials marked lower their assessments of both core inflation and wage growth, implicitly taking some greater comfort in the evolution of both.
Nevertheless, Governing Council is still concerned about the stickiness in underlying inflation and wants to see more cooling in price pressures before waving the white flag. Officials seem like they were only willing to take a half step towards a more balanced approach to monetary policy today. Notably Macklem insisted in his opening statement for the press conference at 10:30am that the central bank will remain focused on the indicators of inflation that officials have mentioned before. In other words, they’re going to keep using the flawed CPI-Trim and CPI-Median measures of core inflation to make policy decisions, which are biased higher at the moment.
Overall, the Bank of Canada wasn’t ready to make a significant change in its message that it’s too early to begin cutting interest rates. However, the rate announcement and opening statement to Macklem’s press conference do acknowledge that the conditions for rate cuts are coming into clearer sight. A significant change in tone will likely occur at the April rate announcement, with cuts beginning in June of this year.
Tiffany Wilding, economist, PIMCO
Overall, we think today’s statement continues to emphasize that policymakers are data dependent and want to see a couple months in a row of lower inflation before beginning the cutting cycle. We thus leave our call for a June start date to the cutting cycle unchanged. There is only one more CPI report before the April BOC meeting and with the lack of a pronounced dovish shift in today’s statement we think it increasingly unlikely that the Bank of Canada starts cutting then.
Ashish Utarid, assistant vice-president of investment strategy with IG Wealth Management
Although we expect a rate cut in the near future, recent GDP figures and job market data suggest the Canadian economy is still holding up enough in the eyes of the BoC. Digging into the GDP report, its net exports, especially from the energy sector, and not internal consumer demand, that were the key contributors to fourth-quarter growth. This helped the economy steer clear of a technical recession and supported the Bank’s decision to maintain the current rate, but under the hood there is evidence that the Canadian consumer is struggling.
There are clear signs the economy has shown signs of a slowdown since mid-last year. The Bank is currently proceeding with caution, struggling with the core inflation levels, which removes more volatile food and energy metrics. The Consumer Price Index (CPI) stands at 2.9% year-over-year, but when mortgage interest costs are excluded, the CPI falls to 1.6% YoY, shelter costs being a large contributor.
The bank is also likely waiting to see what steps the U.S. Federal Reserve will take. But the need for a rate cut is becoming more evident as the economy struggles to gain momentum.
These conditions make a strong case for a reduction in interest rates and the probability is growing that the Bank of Canada will move to loosen monetary policy by mid-year. Such a move would be aimed at reducing the financial strain on consumers, particularly those dealing with mortgages and rent, and help kickstart economic growth in the latter half of 2024. If the Bank doesn’t adjust rates by April, it’s looking more likely that a cut could happen by June.”
Bryan Yu, chief economist, Central 1 credit union
As expected, the Bank continued to preach patience on rate cuts citing persistence in underlying core inflation. ....
While timing will be data dependent, we expect a rate cut in June as economic patterns falter. Particularly, domestic demand is weak with declining per capita performance, and investment has retrenched sharply. There will be a temporary boost in January to GDP from the public sector which will fade, while labour market slack will likely increase. Shelter will be an ongoing challenge for inflation, but a lower policy rate would feed through mortgage interest costs, while the Bank has little influence on drivers like housing supply or immigration. We expect the Bank to “look through” shelter costs as it assesses the timing of a cut.
Claire Fan, economist with Royal Bank of Canada
The BoC’s decision to hold the overnight rate steady again in March confirmed that interest rates are already at levels that are high enough to restrict economic activity and further slow price pressure. We expect the BoC to start gradually lowering the policy rate by mid-year, after allowing for clearer signs of easing in core inflation readings to come through.
Charles St-Arnaud, chief economist, Alberta Central
The key message in today’s decision is that the BoC is not yet ready to consider rate cuts. The Bank continues to be concerned by the persistence in underlying inflation. As we have pointed out on many occasions, the fact that inflationary pressures remain broad, with about 45% of the CPI components still increasing at more than 3%, and the momentum in the BoC still above 3% are the main concern and focus when it comes to inflation.
Overall, in our view, the tone of the Communiqué suggests that the BoC is not yet ready to declare victory in its fight against inflation and that it is too early to position itself for an imminent rate cut.
We believe the BoC will cut its policy rate at the June meeting. We believe that the BoC is unlikely to consider lowering its policy rate until the inflation is viewed as sustainably below 3%. This likely means that its preferred core inflation measures and their momentums are around or below 2.5%, which we do not expect until May 2024. However, a much weaker economy 2024 is a risk that could force the BoC to move sooner. Whether we see an underperformance in hiring or job losses will determine whether we have a hard or soft landing in 2024.
Dominique Lapointe, director, macro strategy, for Manulife Investment Management
Since the Canadian economy continues to hold at close to 0% growth, without clear recessionary signs (read: broader job losses), the BoC has the luxury to wait until it sees more progress on inflation before starting to ease its policy rate. We continue to anticipate more pronounced weakness in the first half of 2024 with final domestic demand continuing to contract on the back of weak household consumption and business investment. If that happens, the BoC would be in a position to signal a shift towards easing at the April meeting, preparing markets for a June cut.
Stephen Brown, deputy chief North America economist, Capital Economics
Given it had only recently dropped the tightening bias from its policy statement, at the prior meeting in January, there was never much chance of any wholesale changes to the policy statement today. The biggest change was the acknowledgment that “wage pressures may be easing,” with the Bank still judging the economy to be in “modest excess supply.”
As the Labour Force Survey still shows very strong wage growth, of 5.3%, the Bank may be shifting to our view that the alternative Survey of Employment, Payrolls and Hours (SEPH) is providing the more accurate steer to wage pressures. The SEPH shows that average hourly earnings growth was just 2.9% in December. Better still, the data released today confirmed that business sector productivity rose by 1.6% annualised last quarter, the first gain since the start of 2022. Together with only a small rise in the quarterly measure of compensation per hour worked, that means unit labour costs declined last quarter. While the annual growth rate is still too high, we have greater confidence that it will continue to slow.
With the economy weak and inflation pressures easing, we continue to think that the Bank will cut interest rates in June. Macklem left the door open to a June cut by noting that, following the positive January data, “one month does not make a trend, you need to see a few months”. While there is obviously a chance that the Bank will wait for its forecast update at the July meeting before loosening policy, even in that scenario we would expect the Bank to deliver more cuts than currently priced into markets. ... we continue to think it likely that the Bank will cut interest rates further over the rest of this year than the 90 bps of cuts currently implied by markets.
Simon Harvey, Head of FX Analysis, MONEX
Reflecting today’s guidance, we now think the BoC is more likely to delay any decision to cut rates until June 5th, a luxury seemingly afforded to them by the strength of the US data pushing expectations of a cut from the Federal Reserve back to July at the earliest. That said, our updated forecast doesn’t reflect what we think the Bank should do, but what it is likely to do. In our view, all Canadian economic indicators uniformly point towards a inflation cooling on a trend basis. This should be reflected in the Bank’s April forecasts and in the results of its Q1 business and consumer surveys released a week before the next meeting. Nevertheless, the BoC now runs the risk of undermining its credibility should it cut in April seeing as it passed up the opportunity to guide markets towards this outcome at today’s meeting. As a result, it will likely use the April decision to setup the normalization path for the remainder of the year.
In delaying the start of the easing cycle, the BoC is putting the economy at undue risk, raising the probability that it will need to cut rates faster and potentially to a lower terminal rate down the line. This makes for an interesting setup for USDCAD. In the short-term, the BoC’s hawkishness should see the loonie retain its defensive capabilities against broad USD appreciation on the back of higher yields. However, this leaves the loonie susceptible to a more significant downside correction later into the second quarter should the incoming Canadian data deteriorate as a result of the BoC’s hesitancy to ease rates sooner. Reflecting this, we maintain our short-CAD bias, but note the period of significant depreciation is likely to be delayed until the mid-Q2.
David Doyle, head of North America economics, Macquarie
Forward guidance remained neutral, reinforcing January’s shift. Statement language was mixed in tone. The BoC remained dovish in its description of growth, but this was offset by continued vigilance on inflation.
Governor Macklem echoed this message in his opening statement and press conference Q&A. To us, this suggests while the BoC sees its next policy move as a rate cut, such a course of action is unlikely near-term.
Our outlook for the BoC is unchanged. We expect 50 bps of easing in 2024. This is less than market expectations (~85 bps) and consensus (100 bps).
We see the first rate cut as occurring in July (vs. consensus in June). Risks are skewed to cuts starting at a later meeting, rather than an earlier one.
In 2025, we suspect the BoC may turn more aggressive (125 bps of cuts) as greater progress is made on inflation and the mortgage renewal cycle becomes a greater headwind to domestic demand.
Derek Holt, vice-president, Scotiabank Economics
What I don’t get is why the BoC would have said they think there are ‘signs’ that wage growth is ebbing. Based upon what, the single month’s softening of m/m average hourly earnings in January? That’s a low bar. You certainly can’t make such a claim in relation to ginormous demands in collective bargaining exercises. And wages continue to outpace inflation. I suppose you could say that productivity improved in Q4, but getting overly excited by that would seem to be ridiculous in relation to the long-term trend. ...
[On the question]: “If the stock market is a bubble then would it make your policy making more difficult going forward?”
Senior Deputy Governor Carolyn Rogers said “There does seem to be some exuberance in equities. We don’t forecast stock prices. Markets are doing the same thing in evaluating when we’ll see a pivot to lower rates.”
Suffice it to say that I wouldn’t be taking stock market tips from the BoC any time soon. I don’t think the BoC has much of a grasp for what’s going on in the stock market. One consideration is the market’s struggles with evaluating the impact of technological change that in the long run probably matters an awful lot more to wealth creation than anything that the little ol’ BoC may or may not do.