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Briefing highlights

  • Poloz should explain shift: observers
  • The case for and against a rate hike
  • Potential reaction if BoC raises rates
  • Markets at a glance
  • Fires hit Canada’s lumber mills
  • Pearson to sell stake in Penguin Random House

'Rate tantrum'

Regardless of what he does Wednesday morning, some observers believe Stephen Poloz has some explaining to do.

There are those who say the Bank of Canada Governor and his colleagues should raise interest rates. There are those who say they shouldn't. And there are those who just want to hear what he has to say.

Many market players expect the central bank to raise its benchmark overnight by one-quarter of a percentage point to 0.75 per cent, though some observers say that's not a lock.

The Bank of Canada began to signal a rate hike when it suddenly shifted its tone in mid-June, in a speech by senior deputy governor Carolyn Wilkins.

Since then, it has said nothing to change the market's general view. And a strong jobs report last week only served to solidify that, as The Globe and Mail's Rachelle Younglai reports.

Bank of Canada senior deputy governor Carolyn Wilkins and Governor Stephen Poloz

Some observers now expect three rate hikes, including one Wednesday, by the end of next year.

This week's decision and statement will be accompanied by a monetary policy report (MPR) and news conference with Mr. Poloz and Ms. Wilkins.

Markets are watching for clues as to the timing of rate increases, and how the central bank sees the economy progressing.

"The BoC has had ample opportunity to walk the market back from July rate hike expectations, and instead chose to reinforce them," said Benjamin Reitzes, Canadian rates and macro strategist at BMO Nesbitt Burns.

"The bigger question markets will be watching for is the timing of the next move (October or January), and how aggressive the BoC will tighten through this cycle."

Then there's the explaining.

Remember, the central bank caught markets off guard when it cut rates during the oil shock. Then it cut again, and then held out the possibility of more.

"The dramatic shift in market pricing suggests that the bank should hike in July in order to remain credible," said Citigroup economist Dana M. Peterson, referring to market expectations and noting that three officials, including Ms. Wilkins and Mr. Poloz, have now signalled tighter policy.

"How? In the July statement, MPR and press conference, bank officials must be clear about the reason for the sudden tightening bias after signaling possible cuts."

The Bank of Canada did not comment.

What to watch for

"The monetary policy report will likely see some moderate forecast changes, mainly on the inflation front. Headline [inflation] … has slowed much more than expected, with energy prices playing a key role. Even so, look for a return to about 2 per cent by mid-2018. On the growth front, the bank did a solid job in April. The 2017 forecast could climb a tick or two, while Q2 isn't likely to move much (maybe a snick higher). A Q3 GDP forecast will be introduced and will likely come in the low 2-per-cent area, above potential but slowing. The overall forecast is expected to be consistent with steady, if slow, policy tightening." BMO's Mr. Reitzes

Should the central bank raise rates?

"Yes, for the reasons we outlined in mid-May. By then, it was apparent that, in contrast to what the BoC was then arguing, the Canadian labour market was not that far behind the U.S. in getting to full employment. Inflation is still muted, but if the economy doesn't need rates this low to make solid progress, for financial stability reasons, we shouldn't have rates this low. Why encourage excesses of debt, and add to the risks that rate hikes down the road will lead to unpleasant surprises for the household sector?" Avery Shenfeld, CIBC World Markets

Or should it hold off for now?

"The economy obviously isn't out of the woods yet, as it is still heavily dependent on housing, record household borrowing and consumption. But with home sales going from bad to worse and new housing construction showing signs of cooling, that support is faltering. Accordingly, raising interest rates at this late stage in the housing cycle would be misguided. … If the bank throws caution to the wind by beginning to raise interest rates [Wednesday], it would likely prove to be the shortest rate hike cycle in Canadian history." David Madani, Capital Economics

'Rate tantrum'

"The speed of market adjustments [with two-year bond yields and the Canadian dollar up] since just before the Wilkins speech on June 12 is a sign of a rate tantrum by markets that were caught flat-footed by the BoC's desire to suddenly spring a surprise and wondering where to next. Further surprises would not be welcomed by either markets or – more importantly – households and businesses. The risk of more such market action to come through a further pile-on into a modest market requires some handholding." Derek Holt, Bank of Nova Scotia

Possible reaction

"A rate hike is pretty much priced into the exchange rate at this point, and the market is expecting two hikes in the coming year. Unless the bank leaves the market thinking that it will remove more stimulus than it put into place in 2015 (which implies three hikes within the coming year), it's hard to see USD/CAD extending below support at 1.2830 [or 77.9 cents from the Canadian dollar perspective] on a sustained basis for now. Alternatively, if the bank eschews a hike … then we're going to see a 'take profit' swing in USD/CAD back to the 1.3200-1.3300 [75.2-75.8 cents] range." Bipan Rai, CIBC

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