A hawkish BoC lean does not endorse market expectations
Looking ahead, our interpretation is that a wait-and-see approach still appears to be the preferred option, though the Governing Council flagged two-sided risks to that baseline, with a skew toward higher rates on balance. For now, we retain our call for no change in rates this year, albeit accompan
The Bank of Canada left its policy rate unchanged at 2.25% following the April policy meeting, matching both our own expectations and economist consensus.
Looking ahead, our interpretation is that a wait-and-see approach still appears to be the preferred option, though the Governing Council flagged two-sided risks to that baseline, with a skew toward higher rates on balance. For now, we retain our call for no change in rates this year, albeit accompanied by rising odds that hikes might come sooner than we had previously anticipated.
Yet despite a modest hawkish shift in the Bank’s updated guidance, we think the Governing Council fell some way short of endorsing the market-implied path for rates.
This indicated 1-2 hikes before year-end, before today’s announcement, with almost two full rate hikes priced post-event. This, we think, is at odds with the Bank’s latest commentary, with several key points catching our attention.
First, the statement noted that the Governing Council will “look through” the inflationary impact of the Middle East conflict, although tempering this with a more cautious point around not letting “higher energy prices become persistent inflation”. Macklem’s opening remarks added a little more colour, conditioning this non-committal stance on the Bank’s new Monetary Policy projections, saying: “Our baseline forecast assumes oil prices will come down and US tariffs will remain at the current levels. If this holds true, a policy rate close to current settings looks appropriate to support adjustment in the economy and return inflation to target.” That suggests little urgency to tighten policy as we see it.
Granted, the Governor did then go on to note that “if oil prices continue to increase, and particularly if they remain elevated, the risk that higher energy prices become ongoing generalized inflation increases. If this starts to happen, monetary policy will have more work to do-there may be a need for consecutive increases in the policy rate.”
Even so, we think that should be read against the countervailing downside risks stemming from USMCA negotiations, which were similarly highlighted, albeit as a potential negative catalyst for growth conditions.
On balance, we will admit that upside inflation risks appear to be the bigger worry for the Bank at present, especially given the focus paid to these throughout the subsequent press conference. But the onus remains on data to show that higher energy prices are translating into more broad-based and sustained inflationary pressures. We think that is a high bar to meet, especially while labour market conditions remain soft.
As such, we think the most likely path for rates remains no change in the next few months.
This view on rates also leaves us modestly more bearish on the loonie when all is said and done. Traders accelerated rate hike expectations again following today’s decision, pushing USDCAD lower to reflect the Bank’s more hawkish tone. However, this only leaves market pricing further detached from our baseline view, posing downside risks to CAD, provided that rate expectations ultimately adjust lower to match our expectations.