Home Economy A ‘Hawkish signal’ from the Bank of Canada is possible next week

A ‘Hawkish signal’ from the Bank of Canada is possible next week

by SuperiorInvest

Capital Economics thinks the central bank will signal that rates need to stay higher for longer to quell cost pressures

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In 2020, with the economy in the midst of an epic recession, Bank of Canada Governor Tiff Mackle pledged to keep interest rates close to zero for several years. Now that inflation is well outside the central bank’s target, investors should brace for a “hawkish signal” that rates will need to stay higher for longer to quell cost pressures, research firm Capital Economics has warned.

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“The Bank of Canada is set to raise interest rates by less than 25 basis points next week,” Stephen Brown said in a Jan. 18 note. A key risk to market prices is that the bank will send a hawkish signal by incorporating new forward guidance that it expects interest rates to remain high for longer than is generally assumed.

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Brown added: “We think (the central bank) will add some guidance to its policy statement about the likelihood that interest rates will have to remain high for the rest of this year and potentially into 2024.

Capital Economics is one of about a dozen research shops that regularly provide commentary on the Bank of Canada. Many are predicting that the central bank will raise its benchmark interest rate by a quarter point at its next policy announcement on January 25, which would mean political rate to 4.5 percent. If they’re right, it would be the smallest increase since Mackle started in March, making it the most aggressive rate hike in the central bank’s history.

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But there is less consensus among Bank of Canada watchers about what’s next.

Economist David Rosenberg, who is widely read on Bay Street and Wall Street, told the audience about Subscribers to Rosenberg Research and the Financial Post On January 19, he opined that central banks have already raised interest rates too high and that policymakers will cut rates sooner than most expect.

Others believe the Bank of Canada will hold off on raising rates next week and then leave markets to guess what comes next. Veronica Clark, an economist at Citigroup Global Markets Inc., thinks the central bank will raise interest rates again in March as inflationary pressures persist.

Brown is the first to suggest that Mackle could opt for forward guidance, a tool central banks use to convince the public that they are serious about achieving certain outcomes.

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This is not the base case of Capital Economics. The firm itself is closer to Rosenberg, predicting that slower economic growth will force the central bank to reverse course and cut interest rates.

But Brown isn’t sure if the Bank of Canada’s outlook will match his. He said many areas of vulnerability remained in the economy, among them business and consumer expectations of higher inflation, and that the central bank might be wary of easing its interest rate guidance. That could prompt the central bank to signal at its next rate decision on Jan. 25 that higher rates could be on hold, possibly into next year, Brown said.

Indeed, inflationary sentiment among consumers and businesses remains elevated.

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For example, the latest Bank of Canada Business Outlook survey found that more than 40 percent of businesses expect inflation to remain above the central bank’s two percent target through 2026. In addition, consumer inflation expectations rose from the third quarter to the fourth quarter of 2022. Respondents said they think a year from now inflation will sitting at 7.2 percent. Their two-year inflation expectations fell to 5.1 per cent, but that’s still well above the Bank of Canada’s two per cent target.

Statistics Canada reported on January 17 that inflation slowed to 6.3 percent year-on-year in December. The consumer price index in November was 6.8 percent. The data agency said most of the headline decline was related to a 13.1 percent year-over-year drop in gasoline prices. There were also signs of a slowdown in other areas, including appliances, automobiles and furniture.

“The bigger issue for the bank is that easing supply shortages and lower price gains have had little impact on inflation expectations,” Brown wrote.

Despite the possibility of a “hawkish signal” from the Bank of Canada, Brown said Capital Economics is sticking to its forecast for a rate cut this year, but has now moved it to September from July.

“Our own view is that the economy will weaken faster than the bank expects, and inflation will also fall faster, allowing it to begin tapering in September,” Brown said in an email.

• By e-mail: gmvsuhanic@postmedia.com | Twitter:

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