One possible reason why we won’t see a rate cut this year is that Canadian markets have already started talking about them. Over the weekend, BMO Capital Markets sent a letter to investors stating their anticipation of a rate increase this week. Currently, they predict a pause in rate hikes by the Bank of Canada (BoC) following the upcoming one, but they caution that this may not be the BoC’s limit. Hikes in the future could be fueled by bullish fundamentals, inflationary concerns, and market anticipation.
The Bank of Canada Is Likely To Raise Interest Rates Next Week
It is widely anticipated that the Bank of Canada will increase its overnight rate this week, marking its entry into the supposedly restrictive terrain it has previously addressed. According to BMO, the overnight rate will increase by 25 basis points (bps), making it equal to its 20-year high. There is anticipation that this will be the highest point for the year, but they caution that further increases cannot be ruled out.
The BMO rate and macro strategist Benjamin Reitzes argues that with inflation still far above target, we predict that Governor Macklem and the Governing Council will keep the door open to further increases just in case the data forces their hand.
He said the BoC may surprise the market by cutting rates before the fall, when cuts are widely expected. There’s reason to think there might be even more hikes down the road
Canada's Base Is Solid, and It May Not Need To Ease
There is much speculation of a recession, yet there are few indicators of a downturn in Canada’s fundamentals. The preferred gauge of inflation used by the BoC, core CPI, is still above 5% and much above the 2% target rate. December’s employment report showed another near record growth, indicating that the economy is still humming along strongly.
The Bank of Canada’s Business Outlook Survey from last week was a major shortcoming. Its data demonstrated a decline in morale, although companies maintained an optimistic outlook. Despite the slowdown, Reitzes argues that it is intentional on the part of the BoC. They’re attempting to reduce inflation by cooling the economy. More dangerous than credit shortages is the possibility of an inflationary spiral.
Moreover, BMO suggests the BoC may raise rates for risk management reasons. They would rather keep inflation under control than have it spin out of control if they are overly permissive. The latter is a more serious issue that requires a more dramatic cooling event to mitigate. In this situation, it’s preferable to err on the side of caution than carelessness.
While there has been some good inflation news as of late, that doesn’t mean the trend will continue. Upside inflation risks still exist, but they have diminished since he made those comments a few months ago.
Due to market anticipation of a reduction, the BoC may be compelled to raise rates
Since the market is already factoring in planned layoffs by this fall, it’s time to start a fresh funding round, right? For precisely this reason, the BoC may be unable to decrease interest rates. A resurgence in economic activity may be possible before it completely dies down if expectations shift in a lenient direction. According to Reitzes, this could lead to even higher inflation before the desired effect is seen.
“While the BoC isn’t excessively busy with the market, improved financial conditions go counter to the purpose of lowering inflation pressure, and cannot be a positive development,” he argues.
BMO believes that a 25 bps raise is warranted on the basis of fundamentals, risk management, and market conditions. Although, as Reitzes points out, the BoC often attempts to surprise. This keeps a central bank relevant by discouraging individuals from taking actions that run counter to its current objective.
That’s why, he advises, we shouldn’t rule out pausing the meeting this week. They still want to go on future excursions, despite this setback. In particular if core inflation proves to be more persistent than expected.