Jan 24, 2023
Economists expect one final rate hike by Bank of Canada before holding
The majority of consumers and businesses are trusting the inflationary period will settle: Economist
Economists predict the Bank of Canada (BoC) will raise interest rates for an eighth consecutive time with a final “insurance” hike on Wednesday before easing off its aggressive tightening policy cycle.
Economists tracked by the Bloomberg terminal are calling for an overnight rate increase of 25-basis-points (bps) on Wednesday, bringing the overall key policy rate to 4.50 per cent.
Sal Guatieri, director and senior economist at BMO Capital Markets, said he takes the “consensus view” of a 25bps hike, given that some recent data suggests the economy is starting to slow down.
Inflation is nearly two per cent lower than its peak in the summer, according to the latest consumer price index report from Statistics Canada, though at 6.3 per cent the annual rate is still well above the central bank’s target of two per cent.
Guatieri said another hike to 4.50 per cent would likely be a final attempt by the central bank to ensure inflation is on track to get in line with its goals.
“I think Wednesday's move, if it (the Bank of Canada) does raise rates another 25 basis points, is more insurance for the inflation outlook,” he said in a phone interview on Tuesday.
University of Toronto economics professor Angelo Melino also anticipates that a 25bps hike is the most likely outcome this week, with the very slight chance for a 50bps increase and “a small but significant probability that they don't do anything.”
DATA-DEPENDENT DECISION MAKING
Since last March, the Bank of Canada has hiked interest rates seven times in a row. The central bank indicated in its last rate hike statement that it would start considering whether it would to raise rates at all, rather than by how much.
Guatieri will be looking for stronger signals in the central bank’s statement this week on whether it is prepared to ease off the hiking cycle altogether after this next announcement.
Andrew Grantham, executive director and senior economist at CIBC Capital Markets, also expects a 25bp hike on Wednesday. He thinks this increase will be “the final one of this cycle” as economic conditions don’t appear to slowed enough for the BoC’s liking.
“Even though inflation has started to ease, it doesn't really give them comfort that they can get down to the two per cent target if they have a faster growing economy than they expected and a tighter labour market than they than they anticipated,” he said in a phone interview on Tuesday.
Grantham said he will be watching to see how the central bank’s decision this week explains its approach to “data-dependent” decision making, which so far has not been clearly defined.
RESILIENT JOBS DATA
Economists also pointed to a stronger-than-expected jobs report in the last quarter of 2022 as a likely source of concern for the BoC. Governor Tiff Macklem has highlighted the country’s persistently high employment rate as a particular concern for the central bank in the fight to bring down inflation.
But Grantham highlighted gray areas in Canada’s jobs data, which surprised economists with its growth in the last quarter.
Grantham published research this month looking at hours lost due to illness among Canadian workers in 2022 from COVID-19 or other respiratory conditions, positing that the phenomenon has forced employers to hire more to keep up with demand.
“It's our belief within our economics team that the low unemployment rate that we have at the moment isn't just a reflection of a strong economy, it's also a reflection of having a sicker workforce than we had in 2019,” he said.
However, past statements suggest Macklem doesn’t agree with that interpretation, Grantham said, and the latest jobs data suggests the central bank will want to tighten further.
PUBLIC EXPECTATIONS AND CREDIBILITY
Melino said the central bank has another major factor to consider: public confidence in its decision making, after 40-year-high inflation rates last year made people take more notice of the institution and its role.
“There's no doubt that the bank has a credibility problem,” he said in a phone interview on Tuesday. “People are paying a lot more attention to what the bank says and what the bank does.”
The last 50 bps rate hike was likely too high for the central bank to pull back to zero now, Melino said, given that not enough time has passed for significant economic changes to take effect, and not hiking rates further could potentially hurt public confidence.
Melino said this week’s rate decision is a significant one, especially with a monetary policy report coming that will forecast its thinking to the public. But he predicted that by March, the central bank will have more breathing room to assess data.
“I think after this decision it (the Bank of Canada) can look at the data without worrying as much about what the impact its decisions will have on expectations and surprising people or disappointing people,” he said.
THE YEAR AHEAD
Guatieri said he predicts the central bank has already raised rates enough to have an impact, and that the economy will enter a “shallow recession” in the first half of 2023. He said it’s likely that the BoC can take a more hands-off approach in the months ahead, depending on data.
“It’s quite possible the bank may need to move again and tighten policy, but our general sense is after Wednesday, they'll probably be on the sidelines for the balance of this year and then perhaps early next year, begin reversing gears.”