I just read some very cogent insights into the Bank of Canada’s rate hike this morning, via the Financial Post (found via their twitter feed, where I get most of my news these days
The following analysis is from Avery Shenfeld, chief economist CIBC World Markets.
The Bank of Canada is like a poker player with a pair of jacks — not sure it has the winning hand, but comfortable throwing in another quarter-point chip at each betting opportunity for now. Having slashed rates to the max during the global economy’s Great Recession, the central bankers are, at this point, only certain that Canada no longer needs such extreme stimulus from monetary policy.
The text of the Bank’s message to markets, therefore, continues to reflect a note of caution. In particular, it
retained its fuzzy language about the future path of rates, saying that subsequent hikes would be “weighed carefully” against the economic backdrop. But just as that language in June did not prevent a rate hike in July, it should not be viewed as a sign that Carney’s team will step away from rate hikes just yet. That pair of jacks — an economic growth forecast that sees Canada returning to its non-inflationary potential by the end of 2011 — is likely good enough to justify a couple more quarter-point moves in September and October.
But by December, the Bank could have enough evidence to go on hold for several months. The Bank acknowledged the deteriorating global growth context in taking 0.2% off its real GDP growth forecast for 2010 and 2011, taking them to 3.5% and 2.9% respectively. The impact on growth from fiscal tightening in Europe, and uneven private sector demand in the U.S., are noted as trouble spots abroad. Oddly, the Bank attributes its revision to Canada’s forecast to weaker consumption than it previously assumed, and actually raised its expectation for the growth contribution from net exports (and business investment). The change in the net export forecast seems somewhat counterintuitive, unless it captures a downgraded outlook for the C$, and the investment forecast also runs against the Bank’s own comment that investment spending is being “held back” by global uncertainties.
The weaker Canadian growth trajectory will delay the attainment of the economy’s non-inflationary limits by two quarters in the Bank’s view, essentially extending the timeframe for the path of interest rate hikes by six months. Since we have the Canadian economy decelerating more materially (with 2010 at 3.3% and 2011 growth of 2.5%), we expect downside surprises to the Bank of Canada’s outlook to see a further softening in their view by year end.
Carney did leave one opportunity to be even more dovish untouched, describing inflation as having run “broadly in line” with his prior forecast, rather than noting that it has, in fact, been a shade below the last MPR projection. Still, the Bank sees 2% inflation as able to coexist with a stimulative stance for monetary policy. We share that view, as a decelerating global economy, and the slack it will leave in Canada’s export sector, should be a sufficient braking force on prices.
The bond market, for its part, had already priced in a very dovish track for the Bank of Canada—too dovish in our view in terms of what lies ahead this year. But Investors took heart from the fact that Carney’s team stayed away from any pre-commitment to further rate hikes in the language, and the downward revision to growth was slightly more than might have been expected. As a result, while overnight rates are now a
quarter-point higher than they were yesterday, anything past December BAs actually moved towards lower yields after the announcement.
So today’s rate hike and soft-pedaled language combined to be a rate CUT for those borrowing at fixed rates. We don’t expect that reaction to last. Further rate hikes in September and October will now come as a surprise to markets, pushing yields across the curve to higher levels, and giving a dose of support to the Canadian dollar.
Avery Shenfeld, chief economist CIBC World Markets
Paul Ashworth, Capital Economics:
Given the very marginal changes in the growth forecasts, it appears the Bank must now believe there is more excess capacity than it did before. At the margin, the bigger output gap estimate suggests that the Bank will be a little more cautious in returning policy to a neutral footing. We still expect Canadian interest rates to end this year at 1.0%. With three meetings left in 2010, the risks to that forecast proably now lie on the upside, particularly given the Bank’s willingness to ignore the weaker data coming out of the US. Nevertheless, we do anticipate a much less aggressive tightening in 2011, as Canada’s GDP growth slows to 2.5%. We see rates ending 2011 at 2.0%.
Dawn Desjardins, RBC Economics:
To our minds, the domestic data is consistent with the Bank raising the overnight rate to 1% at the September fixed action date and 1.25% by the end of the year. External developments related to Europe’s sovereign debt crisis and concerns about the pace of US growth remain a risk to Canada’s growth outlook opening the door to the Bank of Canada stepping to the sidelines to assess the impact of its rate hikes later this year. However, our base case forecast is that the strength in Canada’s domestic economy will persist meaning that the current “emergency” level of rates is no longer warranted. Our forecast is that the overnight rate will be 1.25% at the end of 2010 and 2.75% at the end of 2011, higher than the rates implied by the futures market.
Michael Gregory, BMO Capital Markets:
The Bank’s forward-looking language does not preclude further rate hikes. After all, the same language gave rise to a rate hike today. However, in contrast to June’s statement, the Bank now has more wiggle room to raise rates on a more cautious tact if they want too. And, we think they will. From this perspective, the statement was a bit more dovish than expected. The market has lowered the odds of a September 6th follow-up rate hike to 45%, from 65% before the announcement. Although the Bank seems to be unimpressed by fact that record job creation has occurred in two of the past three months (they repeated June’s dull mantra “employment growth has resumed”), we judge that it should provide sufficient forward momentum in the domestic economy to lead to another rate hike on September 6th. This assumes that domestic economic data will reflect these employment gains and we get no major flare ups on the European or American risk fronts in the meantime. We’ll see.
Francis Fong, TD Bank Financial Group:
The downgrade in the Bank’s forecast for the pace of real GDP growth falls more in-line with most private sector forecasts, and indeed our own, due to a moderation in consumption growth. In late 2009 and early 2010, households boosted their expenditures by taking advantage of the low level of interest rates, but are now more indebted than at any other point on record and will likely take a breather in the coming quarters. Overall, we continue to expect that the domestic factors will play an overwhelmingly dominant role in the Bank’s future decisions. With core inflation remaining fairly sticky to the 2% target, it is imperative that the Bank raise interest rates off the floor relatively quickly and remove a portion of the monetary stimulus floating around the economy, while simultaneously balancing the risk of an undesirably high Canada-U.S. rate spread. We expect a combination of 25 basis point hikes over the next year and a half with the overnight rate reaching 1.25% by the end of the year and 2.5% by the end of 2011.