Sat, Feb 04, 2023 @ 13:03 GMT
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BOC Interest Rate Decision: Foreshadowing the Fed?

Analysts are coalescing around the idea that the BOC will hike by a quarter percentage point (or “one hike” as it used to be) at the next meeting. But given the connection between Canada and the US in economic terms, some traders might be looking at this for some insight into the Fed. After all, both countries are dealing with a similar major problem: high inflation. In the case of the Fed, however, we get the first report of November CPI the day before the meeting, and that could really change expectations. Since the BOC and the Fed have similar economic outlooks, the reasoning the Macklem could use might give some insight into what Powell might say.

Canada took an even more aggressive stance than the Fed, raising by a full percentage point back in July. Canada has also experienced inflation retreating faster than in the US. Since that percentage point hike, the BOC has been slowly curving back its tightening, hiking 50bps at the last meeting. That would put it on track to hike by 25bpts now, and then pause when it meets again in January.

The deteriorating situation

The economy grew by a surprising 2.9% in the summer, which was well above the BOC’s estimate of 1.5%. It helped justify the harsher rate hikes. But, since then, monthly GDP reports have been disappointing, and are on track to match expectations that growth will turn negative in the first half of next year. Just yesterday, the Ivey PMI came in at 50.1, just barely in growth, and well below the 59.5 prior. Although also above expectations, it does show that Canadian businesses are worried about the economic outlook. That helps justify the idea that the BOC will have a lighter touch.

On the other hand, the latest trimmed mean inflation ticked higher for the first time since the summer. That’s the preferred measure of inflation for the BOC, and it moved up to 5.3% from 5.2% prior. Following the last meeting, governor Macklem conveyed a somewhat neutral stance, saying he didn’t want to undershoot or overshoot with policy. Consequently, given the consensus of a “single” rate hike expected, what the governor implies about the rates after is likely to have a bigger impact on the market. If he implies a pause, it likely would be in line with market expectations. But if he were to imply that a hike is probable at the next meeting, it could give a boost to the Loonie.

The widening gap

A 25bps hike would bring Canada’s interest rate to 4.0%, and could be the terminal rate if the pause becomes effective. That would put it on par with the US – for the next week. The Fed is expected to hike by another 50bps, and reach a terminal rate of 5.0% sometime early next year. This would imply that the interest rate gap between the countries would start widening again, and put downward pressure on the Loonie.

The way to avoid this would be if the BOC signals more rate hikes. The other factor to put pressure on the Canadian dollar is that oil prices have also been dropping even after the Russian oil price cap agreed on by the G7, and expectations of China reopening. A weaker CAD would raise inflation concerns for the BOC, and could give them reason to keep hiking beyond 4.0%.

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