Will the central bank start raising rates sooner than expected?
According to traders, the central bank will have to start raising its key lending rate sooner than expected. This will be a serious challenge for the Governor Tiff Macklem.
The swaps market is leaning towards a forecast of an earlier rate increase in 2022, outpacing the U.S. Federal Reserve.
Today, traders expect three rate increases by the end of the next year. As a result, the overnight interest rate in Canada will go up from the current 0.25% to 1% by that time, which is approximately 0.50% higher than the markets predicted only a month ago. The change in forecasts goes against the Governor’s statements that borrowing costs will not be raised until the economic slowdown is offset and inflation reaches the Bank’s target limits.
The BoC has repeated that it will not happen until the second half of 2022.
In analysts’ opinion, the uncertainty around Canadian economic recovery may weaken the effectiveness of the bank’s further guidance.
“In case Macklem decides to start raising rates early, knowing there’s still spare capacity, the entire exit framework will be thrown away”, – Derek Holt, an economist at Scotiabank says. “It will also increase risks for the policy efficacy.”
This change in forecasts, also seen in case of the U.S. and European Central Bank, is partially explained by the fact that price pressures turned out to be more persistent than expected.
On Wednesday, Statistics Canada will provide the latest report on inflation. Economists polled by Bloomberg believe the annual rate will reach 4.3%, marking the highest level in almost 20 years. It could also be the sixth consecutive month of numbers exceeding the BoC’s maximum target limit of 3%.
At the same time, Macklem slightly changed the tone concerning the inflation issue. Although he still considers it to be a temporary phenomenon, he admits the price pressures are more persistent than the Bank initially predicted.
The BoC’s next rate meeting is scheduled for October 27. The borrowing costs are expected to remain unchanged. However, the Bank will probably reduce weekly purchase of Canadian government bonds again – this time from $2 billion to $1 billion. Everyone will keep a close eye on the Bank’s tone in terms of its rate policy and the inflation in the latest quarterly economic forecasts.