Bank of Canada Governor Tiff Macklem acknowledged the potential harm that overly aggressive rate hikes could have on the economy, as the central bank hiked the country’s key policy rate by less than expected.Sean Kilpatrick/The Canadian Press
For a moment, the Bank of Canada looked like the saviour of the world’s financial markets.
In hiking the country’s key policy rate by less than expected, Canada’s central bank provided a glimmer of hope that the fight against inflation may soon be scaled back.
Stock markets globally were imbued with optimism after the announcement on Wednesday, with the S&P 500 index rising by 1.5 per cent by late morning. European stock markets rallied sharply into their closing bells.
It was a short-lived rally, as the gains in the U.S. were more or less wiped out by the end of trading. Clearly, the Bank of Canada hadn’t just single-handedly changed the course of global monetary policy. But it did show that a major economy was at least slowing the pace of rate hikes.
“The Bank of Canada … delivered a clear message that they are getting close to being done with tightening,” Edward Moya, senior market analyst at Oanda Corp., said in a note to clients. “Wall Street is hoping the Fed will follow the Bank of Canada’s lead.”
Interest-rate hikes starting to negatively affect job market, even amid a labour shortage
More than ever, stock markets are attuned to the whims of central bankers. When the COVID-19 pandemic struck in early 2020, it triggered an injection of stimulus and liquidity on a monumental scale. Stock markets rallied fiercely.
Now, central bankers are doing everything they can to remove that excess liquidity in the face of uncontrolled inflation. This has triggered a vicious correction in assets of all kinds, from stocks to non-fungible tokens.
The Bank of Canada has been at the front of that pack. It was the first major central bank to hike its policy rate by a full percentage point, which it did in July. Six consecutive hikes so far this year, including Wednesday’s, have now pushed the overnight lending rate to 3.75 per cent, the highest among the G10 countries.
The synchronized global tightening of financial conditions on an unprecedented scale has taken global stock benchmarks back to their starting point before the pandemic started, effectively wiping out more than two-and-a-half years of gains.
With bond markets providing no solace, investors have had little choice but to either go to cash, or hang on and wait for the great policy pivot. Historically, that has meant central banks actually cutting rates, or at least pausing the campaign. Under the circumstances, rate hikes on a smaller scale will have to do.
“While this may not be the last hike, it’s hopefully the last ‘jumbo’ tightening the economy is subjected to,” Warren Lovely, an economist with National Bank of Canada, wrote in a recent note. “The time for policy rate fine-tuning is now upon us.”
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The shift in tone by Bank of Canada Governor Tiff Macklem was abundantly clear on Wednesday. Up to this point, Mr. Macklem, like his peers, has been almost exclusively focused on conquering inflation, calling it “the most immediate threat to current and future prosperity.”
On Wednesday, Mr. Macklem acknowledged the potential harm that overly aggressive rate hikes could have on the economy. Cracks are already forming. The housing market is falling quickly, consumer spending and business investment is weakening, and Canadian growth is expected to slow to virtually zero over the next three quarters, according to the Bank of Canada’s updated outlook.
For a couple of hours on Wednesday, traders found all of this compelling. But it’s the decisions of the U.S. Federal Reserve around which stock market sentiment truly hinges.
So is a Fed pivot in the works? The economic consensus is that inflation and the jobs market have not yet weakened enough to support a policy change. The market is currently counting on a fourth consecutive hike of three-quarters of a percentage point when the Fed meets next week.
What comes after that, however, is the subject of growing optimism in market circles, wrote Michael Hewson, chief market analyst with CMC Markets. “There appears to be an increasing belief that a Fed pause is close.”
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Tim Shufelt