Canadian markets have begun discussing rate cuts, and that’s a reason we might not see one this year. BMO Capital Markets wrote to investors over the weekend, outlining their expectations for a rate hike this week. Their forecast currently sees the Bank of Canada (BoC) hitting pause after the next hike, but they warn it might not be the top. Strong fundamentals, inflationary risks, and market expectations may fuel future hikes.
Bank of Canada Forecast To Hike Rates This Week
The BoC is expected to raise the overnight rate this week, entering the restrictive territory it has previously discussed. BMO is calling a 25 basis point (bps) hike that will tie the overnight rate with the two decade high. Expectations are this will be the top for the year, but they warn not to rule out the possibility of further hikes.
“…with inflation still well above target, we anticipate that Governor Macklem and the Governing Council will leave the door open to further hikes just in case the data forces their hand,” argues Benjamin Reitzes, BMO rate and macro strategist.
Despite the market generally expecting cuts by fall, he says the BoC may surprise. There are good reasons to not discount the possibility of further increases.
Canada’s Fundamentals Are Strong & May Not Require Easing
There’s plenty of talk of a recession but Canada’s showing very few signs of weakening fundamentals. Core CPI, the BoC’s preferred measure of inflation, is still above 5%—significantly higher than the 2% target rate they try to maintain. Economic activity is still very strong, with employment printing another near record gain in December.
One weak spot was the BoC Business Outlook Survey last week. It showed sentiment is eroding, but businesses still see growth. Momentum is slowing, but Reitzes points to the fact that’s an intended move from the BoC. They’re trying to cool the overheated economy and bring inflation lower.
An Inflationary Spiral Is A Bigger Risk Than Tight Credit
BMO also argues the BoC may hike for the purposes of risk management. They would rather be too tight and fix that with easing later, than too loose and have inflation spiral out of control. The latter is a much bigger problem, and more difficult to pull back without a much sharper cooling event. Being too cautious is better than being too loose in this case.
“While the recent inflation news has been somewhat encouraging, there’s no guarantee that the trend continues. Inflation risks remain on the upside, even if less so than a few months ago,” he said.
The BoC May Be Forced To Hike Due To Market Expectations of A Cut
Get ready to fire up a new investment round, since the market is pricing in cuts by this fall, right? That would be one of the exact reasons that can restrict the BoC from cutting. If expectations slant towards easing, economic activity can start to reignite before it cools down. In this case, they risk further inflation before reaching their goal, argues Reitzes.
“While the BoC isn’t overly occupied with the market, easier financial conditions work counter to the goal of dampening inflation pressure, and cannot be a welcome development.” he says.
BMO sees fundamentals, risk management, and the market pointing to a hike of 25 bps. Though Reitzes notes, the BoC has the tendency to try and surprise. This helps to keep a central bank relevant by preventing people from acting contrary to its goal at the moment.
For that reason, he says don’t rule out a pause at this week’s meeting. Even in this event, they’ll keep the door open for more hikes. Especially if core inflation proves to be stickier than anticipated.