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• BoC hikes by 50 bps to 4.25%, bringing cumulative tightening to 400 bps this year
• Slightly hawkish surprise: consensus was split between 25 and 50 bps
• Soft tightening bias opens the door to a January pause

The BoC lifted its overnight rate by 50 bps to 4.25%, a stronger increase than the 25 bps we expected. Consensus was almost evenly split between a 25 and 50 bp hike though market pricing was leaning toward the former, so yields have increased and the Canadian dollar is a touch stronger in the wake of the decision. The policy statement wasn’t as hawkish as the decision itself—in fact the BoC’s updated forward guidance features a softer tightening bias than we expected. Rather than suggesting the “the policy interest rate will need to rise further,” today’s guidance is that “Governing Council will be considering whether the policy interest rate needs to rise further.” That clearly opens the door to a pause as soon as the next meeting in January, and in our view frames that decision as between 0 and 25 bps.

There’s plenty of data in the next seven weeks that will influence that January decision—two CPI reports, another month’s GDP and jobs data, and the bank’s quarterly BOS and CSCE surveys. We think today’s larger-than-expected hike was due in part to strong labour market data since the October meeting. Indeed, the statement noted “Canada’s labour market remains tight, with unemployment near historic lows.” One jobs report isn’t likely to change that story, but a soft December LFS would help build the case for a pause. And since the labour market is generally a lagging indicator, another muted increase in monthly GDP could also help push the BoC to the sidelines. The bank reiterated its view that growth will essentially stall in the coming quarters.

Today’s statement made note of recent slowing in three-month measures of core inflation—a trend we’ve keyed in on, in addition to evidence suggesting inflationary pressure is becoming less broadly based. Two more months of CPI moving in that direction would likely be enough to keep the BoC on hold—we'd say those reports are likely to be the most influential for January's decision. But with ongoing emphasis on inflation expectations, relevant measures in the upcoming BOS and CSCE will also have to cooperate. Interestingly, the BoC made no mention of firming wage growth in recent Labour Force Surveys, perhaps because the separate payrolls survey calls that trend into question.

The BoC is also likely to be watching changes in financial conditions over the next seven weeks. 5-year GoC bond yields were down 75 bps in the month leading to today’s decision—an easing in financial conditions that may have caused some discomfort and motivated today’s 50 bp hike. A further decline in yields could prompt push-back from the BoC, either through another hike in January or emphasis that rates will have to remain high for an extended period. We expect a challenging consumer backdrop and ongoing pullback in housing will see Canada’s economy slip into recession in the first half of 2023. But with inflation remaining elevated, the BoC isn’t likely to react as quickly to that slowdown as it has in recent cycles.

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The single currency edged against most of its peers on Wednesday and managed to return to territory above 1.05, helped in no small part by published economic data.

In the morning, Germany surprised with a less sharp drop in industrial production, which fell by 0.1% in October against an expected 0.6%. France’s trade deficit narrowed to 12.2bn in October from 17.2bn a month earlier.

The final Q3 GDP reading for the Eurozone showed economic growth of 0.3% QoQ and 2.3% YoY (down from 0.2% and 2.1%, respectively).

The employment growth estimate was also improved, recording job gains of 0.3% QoQ and 1.8% YoY. Employment is supported by the recovery of the economy from the coronavirus restrictions. But the fragmentation of the global economy is also likely to be a factor, forcing European companies to increase local production, reducing dependence on global supply chains (energy from Russia, goods from China).

Interestingly, in contrast to the optimistic Q3 employment estimates, Reuters published a selection of large European companies that have announced layoffs or frozen hiring recently. The dynamics in employment may have already turned from growth to decline, but last quarter’s robust data buys some more time for the ECB to actively hike interest rates, which is suitable for the single currency.

The Bank of Canada raised the overnight rate to 4.25%, while stating that it will continue with Quantitative Tightening (QT).

On rising prices, it stated that "inflation is still too high and short-term inflation expectations remain elevated. The longer that consumers and businesses expect inflation to be above the target, the greater the risk that elevated inflation becomes entrenched."

On economic growth, the Bank stated that "GDP growth in the third quarter was stronger than expected, and the economy continued to operate in excess demand. Canada’s labour market remains tight, with unemployment near historic lows. While commodity exports have been strong, there is growing evidence that tighter monetary policy is restraining domestic demand."

On the future path of policy, the Bank noted that it "will be considering whether the policy interest rate needs to rise further to bring supply and demand back into balance and return inflation to target. Governing Council continues to assess how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding."

Key Implications

The Bank of Canada delivered another 50 basis point hike! With economic growth still running above trend and the labour market remaining tight, the BoC decided that it needed to get rates to an even higher level in order to force the economy back into balance. However, there was a large shift in forward-looking language in the removal of any reference to further rate hikes being required. Prior to today's announcement, the Bank had been signaling the need for more rate hikes, but now it is debating whether it needs to hike rates further at all.

We don't think the BoC is done yet, but it is quickly approaching the end of its hiking cycle. As all Canadians know, the rapid rate hikes over 2022 have caused a dramatic adjustment in the real estate market, and we are starting to see this in consumer spending data. We expect this to continue to weigh on the economy over 2023 as the lagged effects of past hikes filter through. We  expect the BoC will deliver its final rate hike in January, bringing the policy rate to 4.5%. At that time, it can move to the sidelines, allowing the economy to recalibrate and let inflation continue its downward trend over 2023.

Markets

In a session deprived of important data, technical considerations were the main driver for trading. The German 10-y yield at the open briefly dropped below the 1.77% neckline/early October low. The test is ongoing, but there was no trigger to force a real break. The technical picture of the 10-y EMU swap is slightly different as the spread between swaps and bunds narrowed during the decline in yields since early October. Even so the 10-y tested the psychological barrier of 2.50%. The German yield curve turns slightly less inverse, with the 2-y easing 5 bps and the 30-y rising 0.5 bp. The ECB today published its consumer expectations survey. It probably is only ‘secondary input’ for next week’s policy meeting. Consumers’ inflation assessment at least showed that here is still some work to do for the ECB in convincing citizens that it will be able to bring price growth back to 2.0% in a sustainable way. Inflation expectations for the next 12 months rose further from 5.1% to 5.4%. Expectations for inflation three years ahead remained unchanged at 3.0%, an ‘anchor’ still well above the bank’s target. Intra-EMU spreads of late narrowed substantially in line with the decline in LT core yields. This move continues, even as the pace of narrowing is slowing. The 10-y Italian spread versus Germany currently trades near 185 bpn, to be compared with peak levels near 250 bpn end September. US yields traded little changed as US traders joined, but a downward revision in the (albeit outdated) Q3 unit labour cost (2.4% from 3.5%), again revived the bid for Treasuries. US yields decline 7/8 bps across the curve. The US 10-y yield is setting a new correction low well below 3.50%. Risk sentiment remains fragile after yesterday’s WS sell-off as investors ponder risks for a substantial slowdown/recession. Disappointing Chinese trade data only reinforced doubts. US indices again opened modestly lower (about 0.3%). Oil (Brent $79.75 p/b) struggles to avoid further losses below $80 p/b.

The dollar again delivers an unconvincing performance. The decline in US yields apparently more than counterbalances a fragile risk sentiment. EUR/USD (currently 1.053) in a protracted intra-day uptrend easily recaptured 1.05 barrier. Next resistance stands at 1.0595/1.0611-15. DXY also fails to build on a two-day rebound, trading at 104.88 (open 105.63) with Monday’s correction low at 104.11. Sterling trades in lockstep with the euro with EUR/GBP little changed near 0.8625.

News Headlines

The Czech government approved the joint recommendation of the Ministry of Finance and the Czech National Bank not to set a date for adopting the euro yet. The Government considers the unfinished process of economic convergence of the Czech economy, especially as regards the price and wage levels where the distance from the EMU average remains significant, to be an obstacle. The Czech economy also continues to differ substantially in its structure, a factor which might cause problems in the event of the single monetary policy. Given population ageing, the long-term sustainability of public budgets is also not fully resolved. Close trade ties, a relative stable FX rate, still low long-term unemployment and a resilient banking sector speak in favour of adopting the euro, but don’t weigh strong enough. The CNB today also revealed that it sold €79mn of FX reserves last month to support CZK. It’s the lowest amount since interventions started earlier this year. From May, to October, the CNB spent a total of €25.6bn or 15.9% of total forex reserves in April 2022.

Average UK house prices fell 2.3% in November (-0.4% in October) according to mortgage lender Halifax., the largest monthly drop since October 2008 and the third consecutive fall. The annual growth rate dropped to 4.7% from 8.2%. Over the past quarter, they fell by 1%.. The average UK house price now amounts £285,579, which is the lowest since March. Halifax Mortgages Director Kinnaird commented that the market may now be going through a process of normalisation. Some important factors like limited supply of properties for sale will remain,  but the trajectory of mortgage rates, robustness of household finances in the face of the rising cost of living, and how the economy – and more specifically the labour market – performs will be key in determining house prices changes in 2023.

BoC raises overnight rate by 50bps to 4.25%. The Bank Rate and deposit rate are increased to 4.50% and 4.25% respectively. Quantitative tightening will also continue.

Most importantly BoC said it will now be "considering whether the policy interest rate needs to rise further to bring supply and demand back into balance and return inflation to target". The signals the possibility of a pause after today's action.

Regarding the economy, BoC said growth will "essentially stall through the end of this year and the first half of next year". Three-month rates of chance in core inflation "have come down", as an "early indicator that price pressures may be losing momentum". But inflation is "still too high" and short term inflation expectations remain "elevated".

Full statement here.

The Bank of Canada today increased its target for the overnight rate to 4¼%, with the Bank Rate at 4½% and the deposit rate at 4¼%. The Bank is also continuing its policy of quantitative tightening.

Inflation around the world remains high and broadly based. Global economic growth is slowing, although it is proving more resilient than was expected at the time of the October Monetary Policy Report (MPR). In the United States, the economy is weakening but consumption continues to be solid and the labour market remains overheated. The gradual easing of global supply bottlenecks continues, although further progress could be disrupted by geopolitical events.

In Canada, GDP growth in the third quarter was stronger than expected, and the economy continued to operate in excess demand. Canada's labour market remains tight, with unemployment near historic lows. While commodity exports have been strong, there is growing evidence that tighter monetary policy is restraining domestic demand: consumption moderated in the third quarter, and housing market activity continues to decline. Overall, the data since the October MPR support the Bank's outlook that growth will essentially stall through the end of this year and the first half of next year.

CPI inflation remained at 6.9% in October, with many of the goods and services Canadians regularly buy showing large price increases. Measures of core inflation remain around 5%. Three-month rates of change in core inflation have come down, an early indicator that price pressures may be losing momentum. However, inflation is still too high and short-term inflation expectations remain elevated. The longer that consumers and businesses expect inflation to be above the target, the greater the risk that elevated inflation becomes entrenched.

Looking ahead, Governing Council will be considering whether the policy interest rate needs to rise further to bring supply and demand back into balance and return inflation to target. Governing Council continues to assess how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding. Quantitative tightening is complementing increases in the policy rate. We are resolute in our commitment to achieving the 2% inflation target and restoring price stability for Canadians.

Information note

The next scheduled date for announcing the overnight rate target is January 25, 2023. The Bank will publish its next full outlook for the economy and inflation, including risks to the projection, in the MPR at the same time.

WTI crude is down to $73, while Brent is approaching $78, losing 2% since the start of the day and almost 10% since the beginning of the month. Despite rumours about possible quotas cut, OPEC+ keep them for another two months, leading the price to drop. We expect pressure on prices to persist soon, with prices likely to plunge into the $62-65 area.

Despite Russia’s warnings that the imposition of price caps on its oil from G7 and Australia will cause an uncontrollable price spike, the market reaction is quite the opposite. Oil always looks like a leveraged bet on the economic cycle, dropping sharply during the economic slowdown. In addition, the price cap did not cause an immediate supply shock while demand prospects have worsened due to the threat of recessions in the eurozone, the UK and the US in coming months.

Oil traders are not yet frightened by the risks of reducing the global oil supply. Experience with Russian gas substitution has been better than initially feared. For oil, there is also an expectation that the decline in Russian production will be smooth enough, allowing other producers to ramp up supply to increase their market share.

A purely technical view of the price dynamics suggests that the decline is far from over. Oil rewrote the September lows at the end of November and has updated them again today. This looks like a second downside momentum after the corrective pullback from the end of September to 61.8% of the first leg down from June to September. The downside target in this pattern is levelled at 161.8% of the actual move. This is close to $50 per barrel WTI in our case.

However, such an ambitious plan by the oil bears is worth breaking into several intermediate steps. The first support looks to be the $70 area, from which the US government has promised to resume buying oil for reserves. We still need to determine if these purchases will be unlimited, forming a firm ‘floor’ for the price.

The next, deeper support line appears to be the $62-65 area, where the oil turned from a decline to a rise in August and December last year. This is where prices could fall before the end of the year if the US and eurozone economies stop surprising with economic data and China continues to slow.

A plunge towards $50 is possible if the global economy is on the verge of a downturn and oil producers such as sanctioned Russia, Iran, and Venezuela can hold off cutting their production to supplement their budgets.

The Australian dollar is showing limited movement for a second successive day. In European trade, AUD/USD is trading at 0.6696, up 0.12%.

Australia’s GDP misses forecast

Australia’s economy underperformed in Q3, with a modest gain of 0.6% m/m. This was lower than the Q2 print of 0.9% and beneath the 0.7% consensus and also marked the weakest quarterly growth this year. Annual GDP climbed 5.9%, an improvement from 3.6% in Q2 but shy of the consensus of 6.2%. The RBA is projecting that GDP will continue to slow through to 2024. The economy is showing clear signs of slowing down. Services, manufacturing and construction PMIs are all in decline. There was more bad news this week – Current Account for Q3 showed a deficit for the first time since 2019 and Company Operating Profits fell by 12.4% in the third quarter.

Household spending remains strong, but high inflation continues to erode savings and consumers will have no choice but to cut back on spending at some point. Inflation has been more persistent than the RBA anticipated, and Governor Lowe has reiterated that inflation is a “scourge” that must be defeated. The RBA would prefer to avoid a recession, but it will be a tricky task to guide the economy to a soft landing.

The RBA raised rates by 25 bp on Tuesday, bringing the cash rate to 3.10%. The move was widely expected. As a result, the Australian dollar showed a muted response. There was little of note in Governor Lowe’s rate statement, which was almost identical to the November statement. Lowe noted that the RBA expects to increase rates, but “is not on a pre-set course” and rate decisions would be data-dependent. This last point may seem obvious, but events such as consumer spending, employment and inflation will be key drivers which determine rate policy in the early part of 2023.

There is a great deal of uncertainty as to the terminal rate, which forecasts ranging from 3.3% all the way to 3.8%. This means there is some life left in the current rate cycle, and there is a strong possibility that the RBA will deliver another 25 bp hike at its next meeting in February.

AUD/USD Technical

• AUD/USD tested support at 0.6676 earlier. Next, there is support at 0.6558
• There is resistance at 0.6760 and 0.6878