Bank of Canada keeps reducing economic stimulus. When are rate hikes expected?

On Wednesday, the Bank of Canada kept its key lending rate unchanged at 0.25%, but reduced its bond purchases amount once again. Such a decision points to the Bank’s optimism concerning the pace of economic recovery.

Governor Tiff Macklem cut the BoC’s weekly purchases of government debt by one-third to $2 billion. The Bank’s officials noted that no rate increases are expected before at least the second half of 2022, which coincides with the previous forecast.

The economic stimulus reduction brings the return to more normal policy closer, with Macklem being one of the first among his colleagues to start tapering. It’s the third time the BoC has downsized the asset purchase program, supporting the expectations that it will be among the first central banks in advanced economies to raise interest rates.

“This change reflects the on-going progress towards recovery and the Bank’s growing confidence in the strength of the Canadian economic outlook,” – Macklem noted.

The Bank’s decision didn’t come as a surprise for most economists. It remained in line with market expectations of a rate hike cycle starting in the second half of 2022, with several increases necessary to cool the national economy that will probably be overheated in 2023.

Investors are pricing in one increase during the next 12 months, and predict 4 hikes over the next two years. As a result, the overnight rate in Canada will be one of the highest among advanced economies.

Meanwhile, the Federal Reserve isn’t as optimistic as the BoC about the nearest future. The Chair Jerome Powell is planning to tell Congress that the U.S. economy isn’t ready for bond tapering. “We haven’t reached the substantial further progress yet”, – he says.

Investors aren’t expecting a rate increase in the U.S. over the next year. They predict only two hikes during the next two years.

“For now, Governor Macklem remains one of the most hawkish major central bankers,” – Frances Donald, chief economist at Manulife Asset Management, says.

In its recent Monetary Policy Report, the BoC increased its output and inflation forecasts amid growing optimism that households will start spending money they’ve saved in 2020.

Now, the central bank expects households to spend 20% of the excess savings. April’s forecast didn’t include such forecasts. At the same time, the Bank of Canada remained quite cautious in its report, saying the inflation increase is only temporary.

Although it admitted that inflation will still exceed 3% for much of the rest of this year, it still says the growth is caused by gasoline prices, base effects from last year’s lockdowns and supply constraints that should be fixed. They expect consumer price increases to slow down to the target 2% in 2022 due to excess supply.

The next BoC’s rate meeting is scheduled for September 8.