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The Bank of Canada (BoC) maintained its policy rate at 5.00% in the first policy decision of the new year, in line with market consensus and our pre-announcement call.
As such, the policy statement, monetary policy report and comments by Governor Macklem have naturally grabbed market attention, with thoughts increasingly turning to how long the Bank remains on hold. On this point, there was a shift in tone in today’s communications, with the BoC notably dropping its tightening bias from the policy statement. Admittedly, it still made an appearance in Governor Macklem’s opening press conference statement, perhaps inspired by the uptick in the December inflation readings. Even so, this marks an important step towards rate cuts in our view, and we are sceptical that even this modest dose of hawkishness will survive scrutiny for too long. Indeed, it was notable that the BoC’s own forecasts also included a downgrade to inflation projections, despite the pick-up in last month’s figures, with the outlook for growth also seeing negative revisions.
This more closely aligns the Bank with our view of the Canadian economy, which we see as teetering on the brink of recession at present, albeit these latest set of forecasts still look overly optimistic to us
If the economy does slow faster than the BoC predicts, in line with our call, this should see inflation take another leg lower and the BoC cutting rates within the next few months. All told, while we suspect policymakers will remain cautious to expressly telegraph policy easing for as long as possible, there was little in today’s update to convince us to shift our view that April remains the most likely meeting for the BoC to deliver its first rate cut.
Heading into today’s decision, there was little doubt that the Governing Council was set to keep rates at 5.00%. Indeed, we had thought the BoC would simply run back December’s messaging in its entirety given the rise in underlying inflation seen last week. The BoC’s preferred measures of core inflation jumped in December, seeing the average increase from 2.9% to 3.6%. With headline price growth also increasing 0.3pp to 3.4%, the main inflation aggregates provided ample reason for the BoC to not only hold rates, but retain its hiking bias at this meeting. Instead, not only did the Bank remove this part of the policy statement, but other indications from the policy statement also pointed to a dovish shift in thinking amongst the Governing Council. In particular, the Bank acknowledged that mortgage costs and rent are playing a major role in driving inflation pressures. As we noted in our meeting preview, removing these alongside the volatile energy and food components, inflation is tracking below 2%.
Therefore, whilst the Bank did modestly reduce its inflation projections to see inflation easing to 2.8% in 2024, down from 3.0% previously, we think the Bank shares our view that inflation pressures are actually somewhat softer than even these forecasts suggest.
After briefly falling to within the BoC’s target band, the Bank’s preferred measures of core inflation reaccelerated in December, though even this failed to see the BoC retain its hiking bias
The downgrade to the Bank’s inflation forecast was not the only negative revision of note in the MPR. Notably the BoC also revised down its growth figures, with 2023 Q3 GDP now estimated to have fallen by -1.1% QoQ annualised, with the economy flatlining in Q4 and expected to eke out just 0.5% growth in Q1 this year on the same basis.
Even these projections look a little optimistic to us. We think the economy may well be in recession already, a factor that should see inflation cool faster than the Bank expects.
Admittedly, with wage growth remaining elevated around 4%, some upside risks remain. But as noted in the MPR, labour market conditions are easing, confirming signals from the BoC’s latest outlook surveys showing that hiring is set to slow further, with wage growth expected to fall to levels consistent with 2% inflation. Combined with an output gap that has fallen into negative territory, economic fundamentals now argue increasingly for a looser monetary stance.
This need to begin moving towards easing has now seemingly been recognised by the BoC. As noted by Governor Macklem in his press conference, the Governing Council’s discussion of monetary policy is shifting from whether our policy rate is restrictive enough to restore price stability, to how long it needs to stay at the current level. In this context, the Governor’s attempt to emphasise inflationary stickiness and upside risks rang somewhat hollow, not helped by his inability to give a clear answer when questioned directly on the possible timing for rate cuts.
Indeed, we think today’s communications signal the clear beginning of a pivot towards policy easing, one that is likely to come sooner than Governor Macklem is currently willing to admit. If economic conditions continue to evolve as we expect, undershooting BoC forecasts, we think the timing for rate cuts could come as soon as the April meeting.
Whilst the readthrough for FX markets from today’s announcement was partly muddied by the simultaneous release of US PMI numbers which beat expectations, taken together these have seen USDCAD climb close to half a percent, reflecting the market’s dovish interpretation of this latest BoC announcement.
Author:
Nick Rees, FX Market Analyst