The Bank of Canada surprised many economists and money markets by hiking its trend-setting interest rate by 50 basis points on Wednesday instead of a more aggressive 75 basis points.
Markets have responded: Canadian bond yields - which were already softer this morning prior to the rate announcement - sunk further. By noon ET, the two-year government of Canada bond yield was down 26 basis points to 3.89%. The yield on the five-year bond - which heavily influences fixed mortgage rates - was down 23 basis points to 3.43%.
The Canadian dollar immediately tumbled about a third of a cent on the move, although it quickly retraced those losses amid broad-based weakness in the U.S. dollar against major currencies. The S&P/TSX Composite Index shot up about 100 points upon the decision. Even global markets saw some reaction - with the S&P 500 gaining some strength after the decision and 2-year U.S. Treasury yields falling further. It’s a signal that the BoC move has raised speculation that other central banks will soon ease back on the accelerator when it comes to monetary tightening.
The bank now expects 0.9 per cent annual GDP growth next year, down from its previous estimate of 1.8 per cent. While it avoided using the word “recession,” the bank said that an economic contraction is increasingly likely.
The next Bank of Canada rate decision is scheduled for Dec. 7. Money markets are now pricing in a 90% chance of a 25 basis point hike at that time, and less than 10% odds of another 50 basis points, according to Refinitiv Eikon data.
Here’s how economists and market strategists are reacting to the move.
Derek Holt, vice-president, Scotiabank Economics:
This erratic pattern of surprising markets with sudden pivots seems habitual at the BoC. The BoC promised years of staying on hold and reeled in mortgage borrowers by over-stretching its abilities to provide forward guidance and forecast inflation. The BoC ignored all the abundant signs of inflation risk throughout 2021 and then whipsawed everyone this year. Macklem’s December 2021 speech was clearly hawkish and set up priced expectations for a rate hike in January that they whiffed on. The BoC then panicked by hiking 100bps in July and hence more than expected upon suddenly realizing they were way behind in the fight against inflation. [Today they] again surprised markets relative to forms of forward guidance. The BoC needs to be much more careful in its communications in my view.
This is a serious matter because it speaks to the reliability of BoC guidance and using it to infer next steps. If there needs to be longer-lived forward guidance into a future crisis like, oh, say a recession, then borrowers and markets would be extremely well-advised to discount it in a fool me once shame on me, fool me twice (thrice, etc….) shame on you sense.
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Stephen Brown, senior Canada economist, Capital Economics:
Governor Tiff Macklem shifted his tone notably today, reassuring that the Bank was “trying to balance the risks of over- and under-tightening”, whereas previously the emphasis had stressed that it was better to tighten too much rather than too little. The smaller 50 bp hike today – to 3.75% – is the beginning of the end for the tightening cycle, although we still expect 50bp in hikes over the next two meetings.
Today’s smaller hike ... suggests that the Bank of Canada is growing confident that its actions so far will be enough to vanquish inflation although, by doing less than markets were pricing in, the Bank risks sending too dovish a message that it will eventually have to reverse.
Due to its inflation concerns, the Bank reiterated that it still judges that “the policy interest rate will need to rise further”, with future increases “influenced by our assessments of how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding.” At the very least, that means there is one final interest rate hike ahead, of 25 bp, to take the policy rate to 4.00%. Given the recent stickiness of core inflation, we assume the Bank will go a bit further than that, with a 25 bp hike at each of the next two meetings to take the policy rate to 4.25% - lower than the 4.75% we signalled last week and broadly in line with the market-implied peak.
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James Orlando, director and senior economist with TD Economics:
The Bank of Canada has slowed the pace of rate hikes, as it pivots to a more forward-looking policy framework. Given the BoC’s expectation for stagnant growth from now through the end of 2024, the focus is on how past interest rate hikes will weigh on the economy going forward. Though the BoC is not done hiking this year, we are clearly nearing a peak in the policy rate.
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Warren Lovely & Kyle Dahms, economists with National Bank Financial:
It’s increasingly clear that rapid-fire/aggressive rate hikes are working to slow economic growth, not just in Canada and the U.S., but in other key parts of the global economy. While a recession may still be avoided in Canada, GDP growth will be stepping down appreciably, likely nearing stall speed in the first half of the 2023. With growth set to fall far below potential, financial conditions already tight and consumer/business sentiment weakening, there are risks to pushing the policy rate much further into restrictive territory. ...
If, as we expect, Canadian inflation continues to recede rapidly, the Bank may find itself with little more to do on the policy rate, beyond what we believe could be a final rate hike in December. To be clear, the Canadian dollar remains something of a monetary policy wildcard here, to the extent currency cheapness is deemed a risk to imported inflation from abroad. The Bank’s relative policy rate stance is therefore important. While the Fed is not yet done hiking, we likewise see the makings of a less aggressive posture around the turn of the year, an eventual Fed policy pivot likely to lend some support to the loonie in 2023 (and thus gradually easing currency related anxiety at the Bank).
Saying all that, it’s clear that much continues to depend on the evolution of inflation. While this may not be the last hike, it’s hopefully the last ‘jumbo’ tightening the economy is subjected to. We believe it’s time for the Bank to adopt a more data dependent stance, the time for policy rate fine-tuning now upon us. So let us see what the data bring.
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Andrew Grantham and Karyne Charbonneau of CIBC Capital Markets:
While the Bank of Canada slightly under-delivered today in terms of the size of rate hike delivered, its downgraded view of potential growth and continued commitment that interest rates “will” need to rise further doesn’t suggest to us that the peak in interest rates will be any lower than we were expecting heading into today’s announcement. The press conference opening statement suggested that we are getting closer to the end of the hiking cycle and that, barring a large surprise, steps of 75bps are now behind us. This is consistent with our forecast of a peak rate of 4.25%, and that rates will have to stay at that level at least through the end of 2023 to help bring inflation back down to target.
Bond yields fell in response to the smaller than anticipated rate hike from the Bank and continued to fall during the press conference as the Governor emphasized the desire to avoid an overshoot. However, in good news for policymakers given its potential inflationary impact, the Canadian dollar was little changed and actually remained slightly stronger on the day relative to a depreciating greenback.
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Royce Mendes, head of macro strategy at Desjardins Securities:
The fact that core inflation hasn’t slowed, inflation expectations remain elevated and demand is still outrunning supply, the Bank could have easily justified a larger rate hike. That said, the risk of such an aggressive move apparently outweighed the reward. As we’ve long said, the Canadian central bank needed to pivot before its U.S. counterpart as a result of the interest-rate sensitivity of the Canadian economy.
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Benjamin Reitzes, managing director, Canadian rates & macro strategist, with Bank of Montreal:
There’s no debating that 50 bps is still an aggressive move, but the Bank’s decision not to deliver what the market was anticipating was driven by a meaningful downgrade to the economic outlook. The latter is expected to dampen inflation pressures sufficiently, prompting today’s smaller move.
Interestingly, there were no specific comments about the Canadian dollar despite Macklem’s recent musings on the currency. The statement just had one sentence on the US$’s global inflationary impact. Clearly the Bank isn’t that concerned about the C$’s inflationary impact at the moment. Perhaps rightly so, as the C$ quickly shook off initial weakness after the smaller-than-expected hike.
The Bank of Canada surprised markets, but a weakening economic backdrop suggests this ultimately could be the right move. Unfortunately, inflation is still red-hot and has shown no real signs of cooling yet. That’s the fine balance the BoC is trying to achieve, threading the needle of taming inflation while not putting too much pressure on the economy. Today’s decision puts a bit more emphasis on the economy. Hopefully that doesn’t come back to haunt them in 2023 if inflation remains stickier than expected.
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Robert McLister, mortgage broker and Globe and Mail columnist:
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David Rosenberg, founder of Rosenberg Research and Globe and Mail columnist:
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Ted Dixon, co-founder of INK Research and Globe and Mail columnist: