All eyes are on Bank’s of Canada policy rate decision

The central bank will probably keep reducing its economic support at the next policy decision on Wednesday, moving towards the future beginning of interest rate hikes in 2022 amid inflation concerns.

The Bank of Canada’s Governor Tiff Macklem is expected to cut weekly government bond purchases by 50% to $1 billion (US$809 million). It could be the fourth time during the previous 12 months that the BoC has reduced its program that has poured hundreds of billions into the financial system since the beginning of the pandemic.

It’s important to understand that the sooner the Bank stops adding economic support, the faster we’ll face a tightening cycle. Investors believe the central bank will start raising rates during the next six months, and markets expect four rate gains in 2022.

“Inflation turns out to be more powerful than policymakers predicted a few months ago,” – noted Doug Porter, chief economist at Bank of Montreal. “The world has changed and so did the policy.”

The BoC has been using two main tools to keep borrowing costs low: keeping its key lending rate close to zero and purchasing hundreds of billions of government bonds from investors in order to maintain control over longer-term borrowing costs. According to officials, the rate increases will begin when their purchase program flattens.

The main question analysts are asking is whether Macklem will comment on the market’s more aggressive pricing of rates on Wednesday. The governor will speak to reporters at 11 a.m.

The BoC has tried to remain cautious in its forecasts, following the scenario that inflation increase is temporary in an economy that will be weak for some time.

In addition to it, Macklem has been promising not to raise the overnight rate until the full recovery. According to the Bank’s July forecast, it will not happen until the second half of 2022.

However, the inflationary pressures will be a challenge for the central bank.

Consumer price gains have reached their highest level since 2003, and inflation is exceeding the Bank’s target range of 1-3%. Officials will have to raise their inflation estimates on Wednesday.

Earlier this month, Macklem admitted that the supply chain disruptions leading to price pressures are more persistent than expected and it will take more time to reduce the inflation. However, he still follows the transitory opinion.

It would be more difficult for Macklem to signal more aggressive rate hikes (if he wanted) because of the economic growth, which is weaker than the Bank has been expecting. The main reason is an sharp decline in the second quarter after a third wave of COVID-19.

“In our opinion, the Bank of Canada will not validate the recent move higher in interest rate forecasts, instead following its guidance that it will keep the key lending rate unchanged until the economic slack is offset in the second half of the next year,” – Josh Nye, an economist at RBC says.