Today’s Bank of Canada interest rate decision and accompanying statement have been widely interpreted as a “hawkish hold” - keeping rates unchanged while sticking to a message that more rate hikes shouldn’t be ruled out - but markets and economists have already decided what’s next: cuts.
Bond and forex markets barely reacted to the 10 am ET decision. Meanwhile, Interest rate swap markets, which capture market expectations about monetary policy, continue to strongly suggest the interest rate hiking cycle is over, with a greater than 50 per cent chance of the first interest rate cut to arrive in March. A full percentage point cut in interest rates is priced into the market by next October, according to Refinitiv Eikon data.
The following table details how money markets are pricing in further moves in the Bank of Canada overnight rate, according to Refinitiv Eikon data as of 1015 am. The current Bank of Canada overnight rate is 5%. While the bank moves in quarter point increments, credit market implied rates fluctuate more fluidly and are constantly changing. Columns to the right are percentage probabilities of future rate moves.
And here’s how the swaps pricing looked at 4pm on Tuesday, ahead of the BoC decision:
Economists’ expectations for when rates will start to come down vary in timing, but all see 2024 as a year when the Bank of Canada will loosen up monetary policy. Here’s how they are reacting to today’s Bank of Canada decision:
CPA Canada’s chief economist David-Alexandre Brassard
I was surprised that the Bank of Canada remains prepared to raise the interest rate further. There are little to no signs that the Canadian economy requires any more rate hikes. If anything, most economists now have rate cuts in their sights. The assessment that housing costs are driving inflation is on point, but I wonder why there is no mention or considerations around the counterproductive impacts of interest rates on this component of inflation.
Royce Mendes, managing director and head of macro strategy at Desjardins Capital Markets
In holding the policy rate steady at 5.00% for the third consecutive time, Bank of Canada officials acknowledged that higher interest rates are “clearly” restraining household spending and that the economy is no longer overheated. That said, policymakers reiterated that, if inflation doesn’t continue to move towards their 2% target, they are prepared to unleash more rate-hiking pain on the economy.
Central bankers didn’t seem to take much solace in the fact that the average of the three-month annualized rates of their preferred core inflation measures fell below 3% in November. The statement curiously retained language suggesting that core inflation remains stuck in the 3.5-4.0% range. Officials are probably just hesitant to prematurely declare victory in their battle with inflation.
The Bank of Canada will release a fresh set of forecasts in January that could include a slightly quicker return to the 2% inflation target. As a result, it likely won’t be until then that the central bank’s communications take a more dovish turn. Market reaction to today’s release has been limited given that the decision to maintain the policy rate at 5.00% was largely expected and the language in the statement was broadly neutral.
Stephen Brown, deputy chief North America economist, Capital Economics
The policy statement from the Bank of Canada was a bit more hawkish than we expected, with the Bank reiterating that it is still concerned about the outlook for inflation and “remains prepared to raise the policy rate further if needed”. Nonetheless, if the economy continues to weaken as we expect, then it won’t be long until the Bank pivots to interest rate cuts. ...
The decision to leave the tightening bias in the statement may have been an attempt to push back against the shift in market interest rate expectations since the last meeting, with markets now viewing March as the most likely start of the loosening cycle. While the statement noted that “financial conditions have eased”, the rest of the statement acknowledged that tight policy is having the desired effects. ...
The Bank’s main concerns are that wage growth remains in the 4% to 5% range and strong immigration is still putting upward pressure on rent inflation. With the private sector job vacancy rate now lower than the peak before the pandemic, wage growth should slow sharply soon, and there are signs from the visa application data that immigration has also peaked. Against the backdrop of the weakening economy and falling inflation, the Bank needs to start cutting the policy rate soon to prevent the real stance of policy becoming even more restrictive. We agree with market pricing that the first cut could come as soon as March.
Robert Kavcic, senior economist, BMO Capital Markets
With the Bank of Canada looking more like it is done raising rates by the passing week (including Wednesday’s decision), the attention going into 2024 may well turn to rate cuts… how soon, and how much. While we’ll leave those details for another day, the market is moving in that direction. As an example, 5-year GoC yields continue to fall, now down more than 100 bps since early October. Some things to keep in mind heading into 2024:
-Mortgage rates might have peaked, and the 5-year fixed (currently the lowest available on the curve) could drift down based on current conditions. We’re not yet at levels consistent with those that stoked the market in Spring 2023.
-Locking in a fixed-rate mortgage now? Hmm… -Beaten-down Canadian dividend stocks have come back to life, and there seems to be value there if indeed you believe rate cuts are next.
-We continue to believe the neutral rate is higher than the past decade even if/when rate cuts do commence.
Jules Boudreau, senior economist at Mackenzie Investments
The statement accompanying the Bank’s decision to keep rates unchanged at 5% strikes an unambiguously gloomy tone. The Bank sees growth slowing both in Canada and abroad. Even then, the Bank is still too cheerful about Canada’s economic prospects and too fearful of a rebound in inflation. Excess demand has evaporated, the labour market is deteriorating quickly, and it’s only a matter of time before inflation converges to 2%.
The narrative in Canada has shifted from “will we have a recession?”, to “has the recession already started?”. Even if no economic indicator has cratered, data has clearly softened across the board. A “Sahm Rule” for Canada, which uses changes in the unemployment rate to date recessions, is flashing red. With the unemployment rate rising from 5.7% to 5.8% in November, we’ve blown past the classic 0.5% U.S. Sahm rule threshold, and we’re basically at the higher 0.7% threshold, more appropriate for Canada. While we think the Bank should start cutting as soon as January, it won’t, since its lagging core inflation measures will probably still be too high to justify a cut. April is the most probable meeting for an initial cut. We see close to zero chance of additional hikes in 2024.
Some analysts were expecting the Bank to drop the recurring phrase saying that the Bank “remains prepared to raise the policy rate further if needed” from its statement. Although we’re as negative on the cyclical prospects of the Canadian economy as anyone, it’s clear that the Governing Council won’t risk removing that statement before it is ready to begin cutting. At the start of 2023, markets, consumers, and businesses saw the Bank’s tame rhetoric around rates as an indication that it was done hiking. This caused financial conditions to ease and provoked a rebound in growth, inflation, and the housing market. The Bank had to reverse its pause in June. It won’t risk such an outcome this time and will probably keep the screws too tight on the Canadian economy as a consequence.
Derek Holt, vice-president, Scotiabank Economics
The Bank of Canada was hawkish mainly by using patient language toward timing rate cuts. It just wasn’t convincingly hawkish enough to markets that, left to their own devices, are on the path toward reigniting housing imbalances, tamping down how monetary policy works through mortgage resets, inflaming further government spending and driving concomitant inflationary pressures. The BoC needs to adopt a more assertive stance lest they repeat past mistakes by failing to stand in the way of a broadly based easing of financial conditions.
James Orlando, director and senior economist, TD Economics
A hold today was the only option for the BoC. Given the economic backdrop, the BoC has likely gained greater confidence that its policy stance is sufficiently restrictive. There has been obvious weakness emanating from the housing market for a while now, but more recently, consumer spending has slowed alongside a further cooling in the labour market. But with inflation still above 3%, we get why the BoC isn’t ready to declare victory. Instead, the BoC seems like it is preparing to sit on the sidelines for the next couple of months while maintaining its cautious rhetoric.
Markets don’t think the BoC will be able to get too comfortable. The next move is clearly a cut, with odds pointing to the first move in April. We agree. The next few months are going to be challenging given our expectation that the unemployment rate will continue to rise, which will hit consumer spending and bring inflation down along with it. No wonder the Canada 2- and 10-year yields have fallen approximately 90 basis points over the last two months.
Taylor Schleich and Warren Lovely, economists with National Bank Financial
It’s clear to us that the Bank won’t have to hike further (and they probably don’t think they’ll have to either) but they are also clearly not comfortable ushering in bets on earlier and more aggressive easing with inflation pressures not fully under control. There’s a full seven weeks between now and the January decision, so Governing Council will be able to collect more data to further assess how its restrictive policy setting is impacting the economy and inflation. Marginal data will include two CPI reports, a jobs report, October GDP (and November’s flash estimate) and importantly, the winter Business Outlook Survey. If these data come in line with our expectations, the impetus for maintaining a hiking bias will be even further reduced. We could therefore see policymakers make a more material shift in tone, potentially replacing its go-to “we are prepared to hike further” line with something more neutral. Perhaps then it will also be time to start discussing potentially, maybe, at some point in the future lowering rates. In our view, the time for easing isn’t all that far off, even if we’re somewhat skeptical of OIS markets increasingly leaning towards March. We see the first cut being delivered in the second quarter of the year (as soon as April), but we stress that would probably need to be driven by a further deterioration in economic activity and labour market health. Underlying inflation pressures will also have to be printing consistently below 3%.
Avery Shenfeld, managing director and chief economist, CIBC Capital Markets
In not raising rates, the Bank is clearly counting on a move from an overheated economy to one with economic slack to put downward pressure on wage and price inflation, with the usual lags between economic conditions and inflation explaining why we haven’t yet seen enough of that deceleration. The Bank gave a favourable nod to the fact the recent slowing in inflation, unlike the initial move that was concentrated in gasoline prices, has now been “broadening” to more items. Shelter costs were cited as a countertrend given their recent acceleration, but part of that was attributed to higher mortgage rates, which of course could be eased once the Bank of Canada takes policy rates lower. ...
We’ll stick to our view that the Bank of Canada will begin easing by June 2024, a bit later than where markets now see it, but then easing more aggressively than market expectations. We see the overnight rate at 3.5% by the end of 2024, a full 150 bps lower than today, but still twice the peak rate of interest in the prior cycle.
Simon Harvey, head of forex analysis at Monex Europe and Canada
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.
Douglas Porter, chief economist, BMO Capital Markets
The Bank again gamely said that it is “prepared to raise the policy rate further”, even if no one is looking for further hikes, and the conversation has completely moved on to when cuts will commence. Maintaining the hiking bias is likely driven entirely by a desire to continue dampening Main Street inflation expectations and keeping a lid on housing speculators, even as markets are pricing in more than 100 bps of cuts next year.
Given the Bank’s goal of restoring its inflation-fighting credibility among the broader public, the BoC could very well wait as long as possible before shifting to a dovish bias and then to cuts. Assuming the economy doesn’t weaken materially further in the next few months, the policy rate trajectory is entirely dependent on the evolution of inflation. We suspect that while the underlying trend in inflation will improve in 2024, there will be bumps along the way, keeping the Bank on hold a bit longer than the market currently anticipates. But it is safe to say that the countdown clock to rate cuts has begun, even if the Bank isn’t saying so.
Darcy Briggs, senior vice-president and portfolio manager, Franklin Templeton Canada.
We anticipate their communication might start to shift in the first quarter of next year, based on data trends, reassessing the necessity to tighten policy rates again. Notably, 70% of the rate tightening cycle, which includes the BoC’s and the Federal Reserve’s rate hikes, occurred between June and December last year. As we pass the one-year anniversary of these rate hikes, the lagged impacts will amplify and become increasingly apparent in 2024. The current data suggest the BoC’s cycle may have reached its end, with the likelihood of rate cuts in 2024.
Tiffany Wilding, economist with PIMCO
We think the Bank of Canada will remain hawkish in their communications as they seek to push back against a further easing of financial conditions in the near-term, while awaiting more visible progress on wages. Despite this, we think they will begin easing in the second quarter as wage inflation slows in the face of a weaker labour market and policymakers seek to avoid a hard landing given the continued pass-through of higher monetary policy through mortgage renewals.
Darcy Keith