Canada’s oldest bank joined the largest bank in making upward revisions to its rate forecast. BMO now sees the Bank of Canada (BoC) raising even faster than thought. Their economists see interest rates ending at slightly different levels next year. However, the near-term message was the same — expect much higher interest rates by this summer.
BMO Sees The Bank of Canada Making An Additional 50bps Hike
The Bank of Canada (BoC) is sending the message they’ll be aggressive in curbing inflation. Last month, the central bank hiked the overnight rate by 50 basis points (bps). It was the most significant increase since May 2000. These moves, along with yields and the BoC’s language, have forecasts climbing.
BMO now expects an additional 50 bps increase to the overnight rate. That’s one at the June 1st meeting and another at the July 13th. The overnight rate would be at 2%, the highest it’s been since 2008. Once that’s hit, they see the central bank pausing for a few months to assess the situation.
Bank of Canada Raised Its Neutral Guidance, Raising Forecasts
The biggest reason forecasts are rising is the BoC’s change in the neutral rate forecast. A neutral policy rate is where monetary policy neither stimulates or is restrictive. Economies with strong employment and stable inflation should have a neutral rate. Rates are kept below the neutral to help stimulate credit growth and inflation. If credit growth and inflation are too high, rates can move above the neutral to slow incentives.
The BoC raised its neutral rate forecast last month. It’s now in the range of 2% to 3%, up 25 bps from their previous estimate. BMO has forecast we’ll reach the lower end of the range by the end of the next two meetings. They expect the BoC to pause for a few months to assess what’s happening. After, they see hikes of 25 bps at every other meeting, until the overnight rate reaches 2.75% next year.
A moderation of inflation is forecast at this point, allowing rates to cool. However, That’s not the take from the BoC.
Bank of Canada Hints Forecasts May Be Underestimating Rates
In April, BoC Governor Macklem explained they may “take rates modestly above neutral for a period.” In that case, interest rates may climb even higher than the 3% upper bound, at least for a few months. Even at this level, rates would be the highest since 2008, but still low compared to prior years.
The upward revision of the forecast cited similar reasons as RBC did this week. High inflation and a higher neutral policy rate are driving higher forecasts. It’s reinforced by the BoC’s messaging and reiterating its commitment to cool inflation. RBC’s forecast was about 25 bps lower next year, but the takeaways are similar. The BoC is expected to front-load rate hikes to curb inflation ASAP, so expect higher rates this summer.