Bank of Canada's Policy Pause Prompts Bets on Rate Cuts for Year-end
- Written by: James Skinner
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"Indeed, now that the Bank has severely curtailed the threat of further hikes, the natural inclination is to think about cuts" - National Bank of Canada Financial Markets.
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The Bank of Canada (BoC) has initiated a "pause" in its monetary policy tightening cycle following an eighth increase in its cash rate this week but some local strategists say the latest policy step may have been unnecessary and the markets are now betting on the policy rate being cut before year-end.
Canada's cash rate was lifted to 4.5% this week and its highest since before the 2008 financial crisis, making for a 425 basis point increase over the last year and one of the most aggressive tightening cycles on record for the BoC.
"Look, we’re not at the early stages of the recovery anymore. Nor are rates anywhere near neutral," says Warren Lovely, chief rates and public sector strategist at National Bank of Canada Financial Markets.
"It’s why we’ve advised caution on the last couple decisions, and why we feel strongly that pushing out any more hikes would risk seriously deforming the economy. We might not be alone in that assessment," he adds.
Prominent among reasons for this week's rate step was a still-high rate of inflation and an economy that has not weakened as far as envisaged in BoC forecasts, although the NBF team says the latest increases in the cash rate will impact the economy more than others before them.
This is because of what the current level of the cash rate could mean for households with variable-rate-fixed-payment mortgages, which rose in popularity during the pandemic when the cash rate was held at a record low of 0.25% for much of the time.
The National Bank team says that somewhere between 73% and 80% of these mortgages will have hit their trigger rates as a result of BoC policy steps taken in December and January, leaving many facing sharply increased mortgage repayments in a slowing economy.
"To judge from markets, many participants deem this last hike as unnecessary given that it’s expected to be more than fully unwound before the end of this yeart," Lovely and colleagues say.
"Indeed, now that the Bank has severely curtailed the threat of further hikes, the natural inclination is to think about cuts," they add.
Governor Macklem told a press conference on Wednesday that risks to the BoC's new forecasts are "balanced" after the bank lifted its projection for 2023 GDP growth from 0.9% to 1% while crimping its inflation forecast for the year to 3.6%, from 4.1% previously.
Above: Canadian Dollar exchange rates relative to G10 and G20 counterparts for the week to Thursday. Source: Pound Sterling Live.If you are looking to protect or boost your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.
"The biggest near-term risk is that global energy prices could increase, pushing inflation up globally. We’re also concerned that if inflation expectations remain elevated in Canada or increases in labour costs persist, inflation will not come down as quickly as we have forecast," he said.
"Overall, we view the risks around our inflation forecast as balanced, but with inflation still well above our target, we continue to be more concerned about the upside risks. If these upside risks materialize, we are prepared to raise interest rates further," he added.
But after the BoC said "we expect to pause rate hikes while we assess the impacts of the substantial monetary policy tightening already undertaken," financial markets have been quick to bet the cash rate would ultimately be cut from 4.5% currently to 4% before year-end.
This leaves a lot resting on the pace of any further decline in Canadian inflation rates over the coming quarters, and on how the economy holds up under the weight of the tightening delivered so far.
"With the ink on the last hike of the cycle still drying it might not be the best time for the Governor to talk about easing. But if (as we believe) inflation and growth print lower than the BoC expects this year, rate cuts are a topic that will be harder and harder to avoid," Lovely and colleagues say.