WHAT BoC SAYS MATTERS AS MUCH AS WHAT IT DOES.
The market is convinced that the Bank of Canada will hike the overnight interest rate on Wednesday and that means investors will likely be looking beyond the decision itself to what the central bank says ( or doesn’t say) about the path forward.
Futures markets are pricing in a more t han 90- per- cent chance of a 25- basis point hike, which would bring the overnight rate to 0.75 per cent. Barring a rate surprise, investors should be focused on the BoC’s statement and comments from governor Stephen Poloz, given market movements in the past month.
Two- year government bond yields have spiked 40 basis points, and the Canadian dollar has jumped five per cent, since just before senior deputy governor Carolyn Wilkins’s June 12 speech. She stated that first- quarter growth had been “pretty impressive,” and questioned the need to maintain a very accommodative monetary policy.
Poloz echoed her thoughts, confirming the two rate cuts of 2015 achieved their goal.
Scotiabank’s head of Capi tal Markets Economics, Derek Holt, said these dramatic movements amounted to a “rate tantrum” by markets caught flat- footed by the central bank’s new intentions. He also believes the surprise decision has left investors wondering where the BoC will go next. “Further surprises would not be welcomed by either markets or — more importantly — households and businesses,” Holt said. “The risk of more such market action to come through a further pile- on into a modest market requires some handholding.”
With Poloz moving into his first experience leading a rate- hike cycle, the privilege of not providing forward guidance amid ultra- l ow rates will likely fade quickly.
Investors should expect to see more pressure on the central bank to provide more sophisticated communications with markets, whether expressed or implied.
“The BoC has had ample opportunity to walk the market back from July rate- hike expectations, and instead chose to reinforce them,” said Benjamin Reitzes, Canadian rates and macro strategist at BMO Capital Markets. “The biggest question markets will be watching for is the timing of the next move ( October or January), and how aggressive the BoC will tighten through this cycle.”
The central bank cut rates by 50 bps in 2015 in response to the economic pain caused by the dramatic decline in oil prices. While there are still soft spots in the Canadian economy, it has become clearer that emergency low levels of interest rates are no longer needed to support economic growth.
Growth in Canada slowed relative to the U. S. and other countries when the oil price shock hit in 2015, but that followed several years of outperformance.
“The pause in 2015 and, to a lesser extent last year, has clearly ended,” said Nathan Janzen, senior economist at RBC Capital Markets. “It is important to remember that higher interest rates mean monetary policy will be ‘ less supportive’ of growth not ‘more restrictive.’”
He noted that the current 0.5- per- cent overnight rate is only slightly above the record-low 0.25-per-cent rate during the worst of the 2008/ 2009 recession. During that period, Canada’s unemployment rate was two percentage points above current levels. Janzen pointed to the advantages of initiating an earlier and more-gradual rate- hike path, particularly when it comes to adjustments in the highly-leveraged household sector. The economist also noted that growth in Canada during the past three quarters has led the G7 once again.
“Outperformance relative to other G7 countries dating back to pre-2008/ 09 recession levels never fully reversed over 2015 and 2016 and the gap is growing again,” he said.