The Bank of Canada hiked its benchmark interest rate Wednesday by a quarter of a percentage point to 4.5 per cent, its eighth consecutive rate increase. It also provided some significant forward guidance in saying it expects to hold off further rate hikes.
The Canadian dollar and domestic bond yields fell modestly on the news, as overall the bank’s actions were seen as a bit more dovish than expected.
Interest rate probabilities show about 89% odds of the bank making no change to its overnight rate at its next announcement on March 8, according to Refinitiv Eikon data. Money markets are pricing in slim 11% odds of another 25 basis point hike.
But following the bank’s 10 am announcement and Monetary Policy Report, credit markets started making their most aggressive bets yet that the central bank’s key lending rate will start coming down later this year as the bank shifts from inflation fighting to providing support to a slowing economy. They are now fully pricing in a 25 basis point cut by the Oct. 25 Bank of Canada meeting. And they are positioned for an overnight rate of 4.07% by the Dec. 6 meeting. That implies money markets are getting close to pricing in a 50 basis point cut in the overnight rate by the end of this year.
Bank of Canada governor Tiff Macklem, in a press conference, said that rate cuts aren’t yet in the cards. “It is really far too early to be talking about cuts. The pause really is designed to give us time to assess whether we’ve raised interest rates enough to get inflation all the way back to target.”
Yet, economists are also shifting their focus to a possible easing in monetary policy by the end of this year, with some suggesting it’s a strong likelihood. Here’s a snapshot of how Bay Street is reacting:
David Rosenberg, founder of Rosenberg Research
Just as the BoC led in its rate hiking cycle, it is now leading in pivoting towards a pause (“while it assesses the impact of the cumulative interest rate increases”), setting the stage for a similar shift from the Fed in coming months. After the decision, the Canadian dollar was weaker alongside a move lower in GoC yields as the market increasingly prices in the next move being a cut rather than a hike. We agree with this assessment, and fully expect yesterday’s move to mark the final rate increase this cycle. Now, the central bank did give itself an out saying it “is prepared to increase the policy rate further if needed to return inflation to the 2% target.” But, given the wobbly state of the economy, especially the reeling housing market and debt-laden consumer, the pause is far more likely to be followed by a cut, not another hike. Further to this point, the overnight rate, now at 4.50%, is already well past the central bank’s estimated neutral range of 2-3%, which means monetary policy is restrictive by some 150 to 250 basis points. This is sure to bring down inflation fast, with a recession the most likely outcome.
Taylor Schleich, Warren Lovely and Jocelyn Paquet, economists with National Bank of Canada
We’d been hopeful that the Bank would opt for the prudent approach and remain sidelined but in the end, a 25 bp hike was deemed to be the appropriate course of action by the Governing Council. Just as we’d noted in December, we believe the tightening to date is more than enough to bring inflation to target this year and thus, no further rate increases are needed in our view. With policy undoubtedly in restrictive territory, the Bank appears to finally agree. Indeed, as long as economy evolves broadly in line with today’s Monetary Policy Report outlook, they expect to hold the policy rate here “while it assesses the impact of the cumulative interest rate increases.” Clearly, the bar for further hikes has been raised much higher. Moreover, the revelation in the press conference that a move away from a pause would require an accumulation of data suggests that the March decision will almost certainly be for no change.
Despite marking down their inflation projections, the Bank might still be surprised how quickly price pressures moderate in 2023 (in our view, all-items inflation will back to target in the second half of 2023). Of course, inflation data will still be the key determinant in future decisions but the Bank is also surely hoping to see some slack open up in the labour market in the coming months too. Lastly, despite the on-consensus decision, yields fell non-trivially after the decision. The inversion in the curve and expectation for cuts before the end of the year, suggests that the Bank have already gone too far in their tightening campaign. As inflation continues to move lower, we’d expect to see speculation ramp up in regard to if/when rate cuts can be expected this year. We do think the data in the second half of the year will support modest easing and, at least for now, the Bank has not ruled out this outcome.
Stephen Brown, senior Canada economist, Capital Economics
We continue to judge that the Bank is underestimating how quickly inflation will decline later this year, with our forecasts pointing to inflation of 1.8% in the fourth quarter of this year compared to the Bank’s forecast of 2.6%. But even if we are right, the Bank may not be willing to contemplate looser policy until inflation expectations drop sharply. Inflation expectations should decline alongside inflation but, as 70% of firms still expect inflation to be above 2% until 2025 or later, it could take a while for expectations to fully normalise.
The upshot is that we remain confident that today’s hike will be the last, but there is still considerable uncertainty about when the Bank will start to loosen policy again. While our assumption continues to be that high inflation expectations and concerns about its credibility will prevent the Bank from loosening policy significantly even as the economy enters recession, we still see scope for the Bank to return its policy rate to the 2.5% midpoint of its 2% to 3% neutral range estimate by mid-2024. We suspect the Bank will begin to cut in September, a little later than July as we previously suggested. That would leave eight months between the last hike and the first cut, which is broadly in line with the historical norm.
Derek Holt, vice-president and head of Capital Markets Economics, Scotiabank
Governor Macklem threw a strike and promptly headed to the dug out for what may only prove to be a rain delay in the fight against inflation.
In hiking 25bps with fairly strong pause language, and only soft pushback against [credit market] rate cut pricing, his decisions motivated a further easing of financial conditions. .... Whether they are done or not depends critically upon the accuracy of their inflation forecasts over time and how labour and housing markets contribute to such views. ...
It’s not the worst outcome that would have been a total whiff and dovish pause that would have prematurely rung the all clear bell on inflation risk. But it’s a close second. In driving a further easing of financial conditions today, I think the BoC has taken another micro step toward amplifying upside risk to housing, growth and inflation into 2024 and beyond that point which may frustrate their attempts to get inflation durably under control across the full cycle of what lies ahead.
In calling time-out on hikes, they are placing emphasis upon the lagging effects of tightening into this year when the ship has sailed on that outcome; they are paying little to no heed to the lagging effects of market easing into next year and putting a lot of stock in their ability to forecast waning inflation. Uh oh.
Stefane Marion, chief economist and strategist, and Daren King, senior wealth advisor, of National Bank Financial
The Bank of Canada’s latest rate hike will not go unnoticed by the 30% of Canadian mortgage holders who have variable rate mortgages. Between 73% to 80% of variable-rate fixed-payment mortgages originated between 2020 and 2022 will have been triggered during the current central bank tightening campaign. For variable rate mortgages taken out before 2020, the proportion will be 63%, compared to only 25% three months ago. This is what we meant when we said recently that the negative impact of marginal rate increases is not linear at this stage of the economic cycle.
James Orlando, director and senior economist, TD Economics
The BoC’s first meeting of 2023 looks to be the last in which it will raise its policy rate. Heading into today, the Bank had communicated that it could go either way with today’s decision - deciding between a final hike or a pause. Given the robustness of consumer spending and employment trends, the BoC clearly felt it needed this final hike to solidify the turn in economic momentum.
Looking at the Bank’s forecast, the economy is set for a consumer led slowdown, with GDP likely to “stall through the middle of 2023.” Greater conviction in this has also led the BoC to cut its inflation forecast. With the belief that the economy is on the path to price stability, the BoC can now step to the sidelines and let its restrictive policy filter through the economy. Though it does have the option to hike again should inflation prove uncooperative, we are expecting it to hold rates at this level for most of 2023, before cutting at the end of the year to drive a better balance between interest rates being too far in restrictive territory and a weakening economy.
Andrew Grantham, senior economist with CIBC Economics
The Bank of Canada hiked rates by a further 25bp today, but provided some unexpected guidance that this may be the peak for the current cycle. The 25bp increase, taking the overnight rate to 4.5%, was well anticipated by the consensus. The Bank pointed to stronger than expected growth at the end of 2022, a tight labour market and still elevated short-term inflation expectations as reasons for the policy move today. However, the statement also pointed to an easing in the 3-month rates of core inflation, and the expectation that overall inflation will come down “significantly” this year due to the energy prices, improvements in supply chains and the lagged effects of higher interest rates. Possibly because of greater confidence that inflation is easing, the Bank changed its guidance to state that if the economy evolves as it expects then the policy rate will be kept on hold at its current level, although the statement also warned that the Bank was willing to raise rates further if needed. The MPR projections for GDP growth are set at 1% this year and 1.8% in 2024, which is little changed relative to October but a bit higher than our own forecasts. Because of that, we suspect that the economy will indeed evolve in-line or even a little weaker than the Bank suspects, and that today’s hike in interest rates will indeed mark the final one of this cycle.
Ian Pollick, managing director & head, Fixed Income, Currency & Commodity Strategy, CIBC World Markets
The Bank of Canada hiked administered rates by 0.25% this morning as we expected, though the accompanying statement was more explicit than anticipated. Even though we believe this is the final hike of the cycle, trying to remove so much optionality so early into the calendar year is problematic for markets. ...Depending on how you read the wording in the final paragraph, one could interpret the language as this being a period of assessment rather than a hard pause. And in the post-statement press conference, Governor Macklem re-branded the commitment as “conditional”. ...
An obvious question is does the easing priced into this cycle look consistent with those seen in prior tightening campaigns. .... In most cycles markets had expected the Bank to continue hiking, as it is rather unusual to provide such an explicit pause as the Bank provided at the January meeting. Of the four prior hiking cycles, only the 2007 experience saw markets begin to price-in easing within the first quarter following the last hike. On a relative basis it is strange for such an aggressive easing path to be priced so early.
Royce Mendes, managing director and head of macro strategy, Desjardins
The statement now says that the Governing Council expects to hold the policy rate at its current level while it assesses the impact of past rate hikes. That likely ensures a pause in the rate hiking cycle for at least the next few months. Our forecast for the economy in 2023 is more downbeat than the one included in the Monetary Policy Report. As a result, we expect that this will be the final rate hike of this cycle.
Benjamin Reitzes, managing director, Canadian rates and macro strategist, BMO Capital Markets
While policymakers haven’t shut the door on more hikes, the bar for further tightening is quite high. It looks like a March move is off the table barring some wild data. The April policy decision will be more definitive as we’ll have a few employment and CPI reports by then. BMO’s base case remains that the BoC is on hold through the rest of 2023.
Sal Guatieri, senior economist with BMO Capital Markets
Wednesday’s rate hike and conditional pause by the Bank of Canada suggest that, if all goes according to plan on inflation, peak mortgage rates are in place for this cycle. Variable mortgage rates have now pushed above 6%, which is a generational swing from the 1.5% range just a year ago. But, a near-100 bp decline in 5-year GoC yields since October has taken the heat out of fixed-rate mortgages of that term. Five-year fixed rates are now tracking below 5%, with some more downward drift possible in the near term. For the spring market, the BoC’s clear message will instill some confidence in potential buyers that the aggressive upward move in rates is likely done. And, the move down in fixed rates will help affordability a bit, even if there is still some more price adjustment needed. Look for the market to start clearing at these lower prices, and for sales volumes to pick up.
Live updates: Bank of Canada delivers quarter-point hike; key interest rate now 4.5%