Bank of Canada’s forecast of a “soft landing” for economy doesn’t sound that solid now

Canada’s inverted yield curve we’re facing right now means the central bank may bring more interest rate increases and cause a recession. In this case, the Bank of Canada will be in a difficult position as it tries to restrain the inflation and provide a “soft landing” for the national economy.

The Canadian 10-year government bond yield was down by about 0.50% and ended up below the 2-year yield, marking the largest inversion of Canada’s yield curve in Reuters data since 1994 and exceeding the U.S. curve inversion.

Certain experts consider curve inversions to be a sign of the upcoming recession. The Canadian economy is probably even more vulnerable to higher interest rates after Canadians borrowed strongly during the COVID-19 pandemic in attempt to enter the red-hot real estate market.

“It’s quite logical that we would see larger inversion in this cycle than over the previous few because there is so much more of a BoC’s overtightening,” – noted Andrew Kelvin, TD Securities.

“This is what happens when central banks fall behind the curve.”

Just like many other central banks, the BoC considered the inflation “temporary” or “transitory” right into the fall of 2021. They did not raise borrowing costs until March 2022, when inflation was more than twice the 2% target. In June, Canada’s annual inflation reached 8.1%, marking the largest result since 1983.

Investors are worried that central banks across the world will be unable to reduce price pressures without causing recessions. For instance, the Bank of England included a lengthy recession into its forecast last week.

At the same time, the Bank of Canada keeps predicting a “soft landing” in which the economy slows but does not dive into recession.

“Such a scenario isn’t fully impossible, but I don’t believe they will slow down with rate increases because of a recession if inflation remains strong,” – noted Derek Holt, Scotiabank.

As you know, the BoC has raised its key lending rate by 2.25% to 2.50% since March, including a 1% increase in July.

The central bank’s overnight rate is expected to reach 3.25-3.50% in the next months, exceeding the 2%-3% range that the Bank considers neutral (the rate that neither restrains nor stimulates the economy).

Such trends will probably test the resilience of Canada’s economy, including the real estate market, which has shown sharp slowdowns during the previous few months.