Memo 1: Strong job numbers could complicate rate hold plans
This Wednesday, the Bank of Canada officially put its target Overnight Lending rate in a holding pattern, keeping it unchanged at 4.5%. It’s the first time in a year that the trend-setting rate – which also sets the cost of lenders’ Prime and variable-based borrowing products – hasn’t increased.
That’s offered some long-awaited relief to those holding variable-rate mortgages and those who carry balances on home equity lines of credit (HELOCs), who have seen their interest rate – and payments – spike over the last 12 months.
The central bank has indicated they’ll hold rates firm for the foreseeable future as long as economic factors such as inflation continue to trend lower. But this “conditional pause” is proving fragile, with the latest jobs data raising fresh doubts the BoC can hold off on another hike.
According to the February labour report from Statistics Canada, the economy added 21,800 jobs last month, leading to an unchanged unemployment rate of 5%. While considerably lower than the whopping addition of 150,000 positions in January, the numbers are more than double the 10,000 jobs forecasted by economists – and that’s going to put more pressure on the Bank’s upcoming rate decisions.
“As a standalone report, there is nothing particularly remarkable about today's employment update, besides perhaps the snapback in wages. But arriving on the heels of the January jobs jamboree, this result is far too strong for the BoC's comfort,” writes Douglas Porter, BMO’s Chief Economist and Managing Director of Economics.
“There simply is no sign that the labour market is succumbing whatsoever to the rapid-fire tightening of the past year. We won't adjust our call on the BoC just yet, but the economy is likely just one wrong turn on the inflation front away from the Bank flipping back into rate-hiking mode.”
He adds that the persistently tight unemployment rate and growing hourly wages (up 5.4% annually) are higher than the 4 - 5% forecasted by the Bank’s announcement, further “complicating matters” for their rate-hold rationale. Stronger-than-expected labour and wage growth were noted in the Bank’s announcement as key considerations behind whether another rate hike will be in store this year.
Memo 2: BoC needs “more evidence” of cooling economy
Fresh off the Bank’s Wednesday announcement, its second-in-command gave markets more to mull over on Thursday. In a speech given to the Manitoba Chamber of Commerce, Deputy Governor Carolyn Rogers doubled down on the need to see more data before ruling out future rate hikes.
“Yesterday, we decided to leave the policy rate at its current level of 4.50%. We also continued our policy of quantitative tightening,” she stated.
“It’s a conditional pause, though. If economic developments unfold as we projected and inflation comes down as quickly as we forecast in the January Monetary Policy Report (MPR), then we shouldn’t need to raise rates further. But if evidence accumulates suggesting inflation may not decline in line with our forecast, we’re prepared to do more.”
She adds that the data since January has presented a mixed picture, but that overall, the economy is unfolding largely with the Bank’s outlook. While inflation remains “still too high”, she reiterated the central bank’s forecast that it will indeed slow to 3% this year before returning to its 2% target range in 2024.
Memo 3: Markets bet on 0.25% summer hike, as US pressure grows
Rogers also offered some insight into whether the Bank can continue to stick to a rate hold even as the US Federal Reserve – its American central bank counterpart – faces growing pressure to return to larger rate hikes. While its not mandated that the two central banks align on monetary policy, the Bank of Canada risks devaluing the Loonie should Canadian interest rates lag too far behind the US.
Fed Chair Jerome Powell has stated recently that the Fed may need to hike its federal funds rate up to 5.5% or higher as American CPI remains stubbornly elevated. The CAD fell to $0.72 against the USD following Wednesday’s rate hold announcement, its lowest level since last October.
In comments made to reporters following her speech, she said that while the BoC doesn’t directly target the Canadian currency, “Certainly, we will watch the Canadian dollar if there is a depreciation of the dollar against other currencies, particularly the US dollar. The US is one of our key trading partners, that could potentially feed through to some inflationary pressure as import costs go up for Canada.”
Scotiabank economist Derek Holt says at this point, the BoC seems less concerned with the softening currency and remains focused on inflation as the main factor behind rate direction – but that this could prove to be a costly mistake, adding markets are still pricing in another quarter-point hike by this summer.
“If the Fed is on the march to 6% and the BoC is turning dovish at the margin then CAD has 1.40 in its sights,” he writes. “That will challenge the BoC’s assertion that it will be more difficult to pass on cost pressures. I think they did a misstep here and are sitting ducks to currency traders.”
“On balance, I think the BoC is vulnerable going forward and still position the risk to the policy rate moving higher.”
The bottom line
While the Bank’s Wednesday announcement reassured a rate hold in the months to come, the economic data remains a mixed platter. All eyes will be on the upcoming inflation report on March 21st for solid insights as to whether the BoC will truly be in the position to stabilize rates. The next Bank of Canada announcement is scheduled for April 12, 2023.