The Bank of Canada is widely awaited to take on yet another astronomical interest rate rise next week, raising its policy rate into restrictive territory for the first time in twenty years, but bets are split on whether or not a pause will follow.
BoC Governor Tiff Macklem has revealed the central bank is committed to getting “to the top end or slightly above” the neutral rate, the range from 2% to 3% where monetary policy neither revives nor weighs down on the economy. The neutral range has contracted over the last two decades.
That should take place on September 7, with money markets advocating a 75 basis points hike, which would take the policy rate to 3.25%. That would be the fourth huge rate hike in 2022, surpassing 300 basis points of tightening since March.
Several economists forecast the Canadian central bank may indicate a pause after its awaited hike next week, particularly after the announcement on Wednesday of GDP data that indicated the economy may be recovering faster than anticipated.
“Having front-loaded rate hikes, the Bank of Canada may want to pause its hiking cycle allowing the economy time to catch up,” said Taylor Schleich, director of economics and strategy at National Bank Financial. Schleich predicts a 75-basis point rise on September 7.
“From there, we think it becomes a message of data dependence,” he said, pointing out that employment and inflation data both exceed GDP in terms of urgency to the central bank.
Canadian inflation cooled in July to an annual rate of 7.6% compared to 8.1% in June, but stays far above the central bank’s 2% goal, while the unemployment rate is at an all-time low of 4.9%. With underlying price pressures still aggravating, money markets are betting on two 0.25% rate hikes after September, which would raise the policy rate to 3.75% by the end of the year.
Already receiving criticism for responding too slowly when inflation began to advance in 2021, the central bank may be prompted to lean toward a more restrictive outlook.
Andrew Kelvin, chief Canada strategist at TD Securities, stated:
“The Bank of Canada is trying to defend its credibility as an inflation targeter. Falling short of market expectations would raise uncomfortable questions around the BoC’s commitment to the inflation target.”
Still, he perceives the market call of a 3.75% policy rate as too sharp, expecting it instead to climb to a cycle peak at 3.50% next month.
Other economists do not exclude surprises. Chief economist at BMO Capital Markets, Doug Porter, pointed out that nominal spending is “barreling ahead” at its highest rate – outside the initial coronavirus pandemic rebound – since 1981.
“We now look for a 75-bp hike next week, with an outside chance of a larger move (a la their July 100 bp surprise),” Porter said in a note. In the long run, inflation will be the determining factor.
National Bank Financial’s Schleich said:
“At the end of the day, the mandate is 2% inflation. If that doesn’t continue to moderate, there will be no choice but to keep things restrictive and keep hiking.”