What to Expect — Bank of Canada Meeting
‘Rate hikes are coming’. This is the chant that has been chorused for some time now on Bay Street, and that chant has only gotten louder in recent weeks as the market now expects the Bank of Canada (BoC) to act to keep inflation in check. What the market cannot seem to agree on is timing of the first hike. While some believe it will happen as soon as tomorrow, others have wagered bets on it being put forward till March 2022.
Nevertheless, we all can agree that inflation is on the rise and its impact is being felt in our everyday lives.
December’s CPI was up to 4.8 percent from 4.7 percent in November, putting it at a level not seen since September 1991. Prices rose across 5 major components (gasoline prices, food prices, homeowner’s costs, utilities cost and motor vehicle prices), with the key drivers being supply constraints, surge in shipping costs, and increase in commodity prices. Many Canadians think inflation will remain high over the next two years, although, it appears consumers remain undeterred in spite of this, as strong spending growth is still being expected in the near term, according to the Survey of Consumer’s expectations published by the BoC.
Another factor which we believe might push the BoC to act swiftly is their perception about economic slack. The Bank of Canada has persistently stuck to the narrative that this indicator will be key in their decision on when to start raising interest rates. Many analysts now believe the slack is near full absorption, if not fully absorbed. Annualized GDP growth for Q4, 2021 is projected to hit around 5.5 percent while the labor market also had a strong finish as unemployment rate fell to 5.9 percent in December of 2021 marking a seventh straight month of decline.
Rising commodity prices is another one the BoC will be keeping an eye on, especially with oil prices marching higher on the back of geopolitical tensions and economies reopening. While higher oil prices mean more revenue to the government, it also means we have to pay more at the pumps.
Furthermore, the BoC cannot afford to be behind the US FED in moving rates. The Fed came out very hawkish at their December 2021 meeting, signaling its readiness to move rates much earlier than expected as Fed Chair Powell noted that inflation was the greatest risk to achieving their full employment mandate. Though, we do not expect them to announce a hike tomorrow, we do anticipate more tapering measures to be announced as it readies the market for a liftoff probably before end of Q1.
We cannot help but talk about how the Financial Markets has reacted so far to all these speculations. 5-year bond yield has been up 38bps year-to-date, while the Overnight index Swap market is pricing in at least 5 hikes this year, with some forecasters even bravely predicting as many as 7-hikes this year.
Whatever path the BoC does take tomorrow, they will probably find people sympathetic to any decision they arrive at. It will be understandable if they decide to wait till March to begin raising rates. After all, some components of this inflation can be tied to supply chain bottlenecks and labor shortages which would not go away by merely increasing rates. One cannot also fault them, if they do pull the trigger tomorrow to stay ahead of the inflation curve. Some hawks have even blamed the rise in inflation on loose monetary policy which they believe can only be tackled with higher interest rates.
For now, I will steer clear of placing a bet on the path BoC will choose tomorrow, but will mention, it will be a brave move for the BoC to bet against the market, and now, not only is the market chanting for a rate hike, but they have also already priced it in.
