Bank Of Canada To Hike Into Restrictive Range: Decision Guide

(Bloomberg) -- The Bank of Canada is set deliver a fourth consecutive outsized interest-rate hike to slow the nation’s economy and drag inflation down from four-decade highs.

All 31 economists surveyed by Bloomberg expect policy makers led by Governor Tiff Macklem to raise the benchmark overnight rate by at least 50 basis points, and most say it will be 75 basis points. That would bring the policy rate to 3.25%, the highest among major advanced economies. 

All six of Canada’s major commercial lenders favor a bigger a move, along with Goldman Sachs and JP Morgan. UBS and Moody’s are among the handful expecting a half-percentage-point hike.

Investors will be looking for clues on whether more will be coming in October, amid discussion that the hiking cycle -- one of the most aggressive in the bank’s history -- may be near its end. Officials have already raised the key rate to 2.5% from 0.25% in March in what they termed a “front-loading” effort, starting with a standard quarter-point move and ramping up to a surprise 100-basis-point jolt in July. 

“A further softening in household demand is still required to bring inflation back to the bank’s 2% target rate,” Royal Bank of Canada economists Nathan Janzen and Claire Fan said in a Sept. 2 report to investors. But “if household demand and inflation pressures wane as expected, the bank could be in a position to halt its tightening cycle soon.” 

The statement-only decision, due Wednesday at 10 a.m. in Ottawa, won’t include a press conference or new set of economics forecasts. However, a speech Thursday by Senior Deputy Governor Carolyn Rogers may shed more light on the bank’s thinking. 

A 75-basis-point hike Wednesday would leave Canada with its highest policy rate since 2008, and bring borrowing costs to a level that will actively slow economic growth. (The so-called neutral range for rates, which neither stimulates nor restricts activity, is estimated to be between 2% and 3%.)

Monetary authorities around the world are slamming on the brakes to halt a post-pandemic surge of inflation. The Reserve Bank of Australia raised its policy rate by a half-percentage point Tuesday, and the European Central Bank is expected to deliver a 75-basis-point hike on Thursday. The US Federal Reserve meets later this month, with an increase of at least 50 basis points expected.  

Most economists see Macklem’s forceful tightening as the right play, with Canada’s economy still overheating. Job vacancies are at a record high, and unemployment is at record lows. Pay increases remain at elevated levels as workers demand additional compensation for shrinking real incomes, risking a wage-price spiral.

And inflation, though showing signs of peaking, is still running at an uncomfortable 7.6%, nearly four times the central bank’s target. With core measures and service inflation still rising, there’s a risk that sticky underlying price pressures could still become entrenched, keeping pressure on Macklem and his officials to further tighten policy.

What Bloomberg Economics Says...

“Activity is moderating, particularly in rate-sensitive housing, where Canada ranks unfavorably on our bubble metrics. Still, that won’t outweigh the fact that inflation is too high for comfort ahead of potential supply disruptions emanating from Europe or China this winter. The BoC’s focus on core inflation leads us to expect hikes of 50 bps in October and 25 bps in December.”

-- Andrew Husby, economist

For the full analysis, click here

“It will take some time before inflation is back to normal,” the governor said in a newspaper opinion piece on Aug. 16, after Statistics Canada reported a slight deceleration in headline inflation. “We know our job is not done yet -- it won’t be done until inflation gets back to the 2% target.”

Most analysts expect policy makers to echo that language this week. “At this point central bankers still need to remain hyper-vigilant,” Royce Mendes, head of macro strategy at Desjardins Securities, said by email. “The Bank of Canada probably won’t be surprising markets with any dovish signals.”

Another hawkish surprise, however, can’t be ruled out. While Toronto-Dominion Bank predicts a 75-basis-point hike, securities strategists led by Andrew Kelvin put the chances of a second full-percentage-point dose of tightening at 25%, compared to a 10% chance of a 50 basis-point move.

Evidence is mounting the rate increases are starting to bite. While the economy generated strong growth for much of the first half of 2022, output has largely stalled since May as housing markets across the country reel from higher mortgage costs. Some economists even see a recession next year. 

A pause in hikes may be fast approaching, even if policy makers don’t outright signal one this week. Both markets and economists predict the tightening cycle will end with rates at about 3.75% by the end of this year.

The consensus is the central bank will ultimately pull off a soft landing -- a Goldilocks scenario where inflationary pressures are subdued by the end of 2024 without any significant economic downturn. 

While the Bank of Canada may have lost some credibility in its late response to soaring consumer prices, it appears to have been redeemed by its quick pivot. Still, there’s plenty of uncertainty around how restrictive borrowing costs will impact the economy.

“The coming months will be where the rubber meets the road in terms of monetary policy,” Mendes said. 

(Updates with odds of 100-basis-point move in 13th paragraph, freshens Bloomberg Economics tout.)

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