The BoC defied the bulk of economists today, as it hiked its benchmark overnight rate by 25bps to 1.00%, the second consecutive meeting where the BoC has delivered such a move. Only 6 of the 33 surveyed in the latest Reuters Poll expected the BoC to tighten policy today while interest rate markets were pricing a 45% chance of such a move.
In terms of the hike, the BoC was of the view that “today’s removal of some of the considerable monetary policy stimulus in place is warranted. Future monetary policy decisions are not predetermined. Particular focus will be given to the evolution of the economy’s potential, and to labour market conditions.” In the wake of the decision Manulife’s Senior Economist, Frances Donald, suggested that “the Bank of Canada feels it is behind with growth and the output gap is the focus.”
The move surprised many, as the BoC’s voting members have refrained from making any public appearances since the July hike. Manulife’s Donald noted that “in June (the Bank) didn’t want to slam on the brakes at the last second. I don’t think they’ve avoided that here by hiking today.”
The Canadian economy experienced a stellar Q2, culminating in a much stronger than expected GDP reading for the quarter. On the economic data front the BoC noted that “recent economic data have been stronger than expected, supporting the Bank’s view that growth in Canada is becoming more broadly-based and self-sustaining. Consumer spending remains robust, underpinned by continued solid employment and income growth. There has also been more widespread strength in business investment and in exports.”
The Bank noted that GDP is higher than it expected but “continues to expect a moderation in the pace of economic growth in the second half of 2017.” The BoC did appear a little more optimistic regarding the global economic backdrop, but warned of the lingering spectre that US trade and fiscal policy is casting at present.
For the domestic currency, the BoC attributed the CAD’s strength to broader USD weakness as well as “reflecting the relative strength of Canada’s economy.”
It is fair to say that inflation remains lacklustre, with many citing a lack of upwards price pressure as a reason for the BoC to hold off on tightening pre-decision. The Bank’s view on this matter is that “there has been a slight increase in both total CPI and the Bank’s core measures of inflation, consistent with the dissipating negative impact of temporary price shocks and the absorption of economic slack. Nonetheless, there remains some excess capacity in Canada’s labour market, and wage and price pressures are still more subdued than historical relationships would suggest, as observed in some other advanced economies.”
Housing remains a worry for the BoC. The key passage on this front stated that “given elevated household indebtedness, close attention will be paid to the sensitivity of the economy to higher interest rates,” although the recently introduced macroprudential tools seem to have been effective in the regions where they have been implemented. The BoC have noted these developments, stating “the housing sector appears to be cooling in some markets in response to recent changes in tax and housing finance policies.”
Looking forwards, Bloomberg reporter Luke Kawa believes that “in October, the BoC will be able to stand pat and explain in presser why it’s standing pat to gauge effect of higher rates on the economy.”
ING believe that “with inflation well below target at 1.2%, which the BoC acknowledge, we suspect there will be a pause in monetary policy to see how the situation develops. We suspect the policy rate will remain at 1% through to year end with two further rate hikes in 2018.”
In terms of market reaction, the USDCAD moved from circa 1.2410 to just below 1.2140, before the pair regained the 1.22 handle. Manulife have suggested that the “USDCAD can get to 1.20.” Canadian 10-year government bond yields moved from circa 1.880% to 1.935% over the announcement, before paring back and stabilising around 1.910%, with swaps now pricing in a 45% chance of an additional 25bps hike by year end. CIBC (one of those looking for a hike today) noted that “markets may be overpricing the probability of another move in 2017.” National Bank are more aggressive as they are “still calling for a rate hike in December, at which time more information will be available about the extent of fiscal stimulus both at the federal and provincial levels (e.g. pre-election spending in Ontario and Quebec).”