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The Bank of Canada held its policy rate at 5% today for the third successive meeting since it resumed its hiking cycle back in the middle months of the year.
Motivating its decision to hold rates was the view that the economy has essentially “stalled” through the middle quarters of the year, with consumption growth and business investment effectively non-existent. This is consistent with our view of the latest GDP readings, even as overall weakness in the Canadian economy wasn’t obvious in the headline growth rates. The Bank also noted that weaker growth conditions are now actively dampening inflation pressures, with employment growth struggling to keep pace with the expansion in the labour force and its favoured core inflation measures now breaking below the 3.5-4% range they have held year-to-date. With the Bank’s economic assessment turning materially more dovish, the main surprise in today’s policy statement came from the Bank’s decision to retain its hiking bias, noting that the “Governing Council wants to see further and sustained easing in core inflation” and is “prepared to raise the policy rate further if needed”.
In our view, the contrasting signals from the dovish economic outlook and hawkish forward guidance highlights a Governing Council that is desperately trying to prevent markets from pricing in an earlier and more aggressive easing cycle to try and retain some credibility should inflation pressures reaccelerate in the near-term for an unknown reason. However, that is at odds with the economic reality that the Canadian economy essentially on the precipice of a recession.
With the next few rounds of data set to display a more uniform message of economic weakness and the BoC’s next decision accompanied by a fresh set of economic projections, we expect the Bank will need to officially open the debate to policy easing in January, before cutting rates in April. However, with slack rebuilding in the labour market at an aggressive pace and this likely to flow through to weaker measures of wage growth, there is a material risk that the Canadian economy will enter 2024 in an outright recession.
If confirmed by the data, we think there is a credible risk that the BoC will be forced to front-load its easing cycle with a 50bp cut as early as March, before rapidly loosening policy back to the neutral range of 3-3.5% by end-2024 in order to limit the extent of the recession.
Turning back to today’s decision, the response in markets was fairly nascent, with USDCAD remaining in the mid-1.35 range and pricing of the BoC’s easing cycle in 2024 virtually unchanged. This reflects the strong consensus that had formed ahead of today’s decision, with most expecting the Bank to retain its hawkish bias in order to delay any discussion of policy easing until 2024.
We expect policymakers will also take this stance in the final two public events of the year, seeing as both Deputy Gravelle on the 7th and Governor Macklem on the 15th are scheduled to speak ahead of November’s inflation report on the 19th, which we expect to show the Bank’s preferred core inflation measures falling back to the 2% target for the first time since February 2021.
Author:
Simon Harvey, Head of FX Analysis