Expectations for today’s Bank of Canada release were fairly muted given the arrival of the Omicron variant and the risk it poses to the economy in the near-term.
That being said, Friday’s release of an outstandingly strong November labour market report meant increasing focus was on the Bank’s assessment of when the output gap is set to close and whether they would embolden market expectations of a Q1 rate hike by bringing forward their estimate from the “middle quarters” of next year. However, despite the Bank dropping hints that their preference is to raise rates amid the more inflationary backdrop, growth risks brought about by the latest Covid variant and the recent British Columbia crisis meant policymakers kept a fairly noncommittal tone in today’s press statement.
The Canadian dollar mildly weakend on the back of the release as there was no material upgrade to the Bank’s October projections in the statement.
However, the brief spike in USDCAD after the announcement was quickly retraced as the tone of the rate statement showed increasing sensitivity to the current inflationary backdrop. This, in our view, confirms the current market pricing of a rate hike in H1 should the current risks to the economic outlook abate by Q1. Placing the timing of the rate hike within H1 is highly uncertain, however. The emphasis on January’s meeting is substantial in this respect as by that point, markets should have a clearer understanding of the growth risk posed by the variant. Should it be minimal due to elevated vaccine efficacy, the BoC will likely use January’s meeting to set up a rate hike as early as February. However, if risks remain or economic conditions moderate ahead of the January meeting, we think there is value in the BoC delaying lift-off until April’s meeting in order for it to be delivered with all communication channels open. With this uncertainty in mind, markets will be paying close attention to Deputy Gravelle’s economic assessment tomorrow for further guidance.
USDCAD briefly spikes following BoC release, emphasis is now on Gravelle tomorrow
Author: Simon Harvey, Senior FX Market Analyst