The Bank of Canada surprised markets on Wednesday by delivering a lower-than-expected 50-basis-point rate hike, its sixth consecutive rate increase of the year.
That brings the benchmark rate to 3.75%, 350 basis points higher compared to where it began the year.
Markets had overwhelmingly expected a 75-bps hike following the release of September inflation data, which showed price growth still stubbornly high.
But the Bank’s decision to hike by only 50 bps signals potential concerns about weakening economic growth and a softening labour market.
According to Josh Nye of RBC Economics, it also suggests the “peak is near.”
In its statement, the Bank acknowledged that interest rates will need to rise further, but that future increases, “will be influenced by our assessments of how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding.”
In a press conference following the announcement, Bank of Canada Governor Tiff Macklem noted that future rate moves could include “another larger-than-normal step,” or “more normal, smaller steps.”
“We are getting closer to the end of this tightening phase, but we’re not there yet,” he said, adding that the BoC is “trying to balance the risks of under- and over-tightening.”
Reaction to the BoC’s decision
Market reaction was swift, with bond yields ending the day roughly 25 basis points lower.
Ryan Sims, a mortgage broker with TMG The Mortgage Group and a former investment banker, accurately predicted Wednesday’s 50-bps rate hike. He said it was a “measured way of the BOC saying that increases are starting to work.”
“Generally, the central banks don’t want to do something that is not expected, or else they risk losing credibility,” Sims told CMT. “But for some reason, they thought 50 was appropriate, when the market thought 75. They may be seeing some early data from October, or some metrics that they think will continue, so they leaned towards a smaller raise.”
Warren Lovely at National Bank of Canada said that it may not be fair to say the Bank blinked, but that “pragmatism now looks to trump dogma.”
“That may leave the Bank out of alignment with the Fed in the near-term… at least until the FOMC recalibrates its own thinking in response to accumulating economic damage,” he wrote in a research note.
“That the Bank is prepared to lag the Fed at this late stage of the tightening cycle is perhaps appropriate given Canada’s outsized reliance on housing and commodity prices that are now declining,” he added.
“Is this the pivot markets, businesses and homeowners have been waiting for? It looks like it could be,” asked Randall Bartlett, Senior Director of Canadian Economics at Desjardins. “With monetary policy acting with long and variable lags, the Canadian economy hasn’t yet felt the full impact of interest rate hikes this year, and the risks remain tilted to the downside.”
Looking ahead to the Bank’s next rate decision on December 7, most economists say the choice is between 25 bps and 50 bps, and that it will be largely dependent on economic data that will come out in the meantime.
The BoC’s latest forecasts
The Bank of Canada also released its latest Monetary Policy Report (MPR) today. Here are the highlights of its updated forecasts:
The bank expects consumer price index (CPI) inflation to average:
6.9% in 2022 (vs. 7.2% in its previous forecast)
4.1% in 2023 (vs. 4.6%)
2.2% in 2024 (vs. 2.3%)
“The Bank’s preferred measures of core inflation are not yet showing meaningful evidence that underlying price pressures are easing,” the BoC said in its statement. “Near-term inflation expectations remain high, increasing the risk that elevated inflation becomes entrenched.”
The Bank now expects annual economic growth of:
3.3% in 2022 (from a previous forecast of 3.5%)
0.9% in 2023 (from 1.8%)
2% in 2024 (from 2.4%)
On growth, the BoC said, “The effects of recent policy rate increases by the Bank are becoming evident in interest-sensitive areas of the economy: housing activity has retreated sharply, and spending by households and businesses is softeningEconomic growth is expected to stall through the end of this year and the first half of next year as the effects of higher interest rates spread through the economy.”