MNI BOC WATCH:Hot Economy Gives Pause For Thought About Hiking

The Bank of Canada is seen by a majority of economists as holding its key interest rate at the highest since 2007 Wednesday, though many warn an increase is a significant risk given the economy's continued strength.

Nineteen economists surveyed by MNI see the target rate on overnight loans between commercial banks remaining at 4.5% and another four see a quarter-point hike at the decision due at 10am EST from Ottawa. Among Canada's five major commercial banks, two see a hike and the remaining three view the decision as a coin toss.

That’s a sharp contrast from a few weeks ago when bets were often on a rate cut later this year to fend off a recession. Surprises are also hard to rule out given that four of the central bank's eight decisions last year bucked the economist consensus.

Following another quarter of stronger-than-expected GDP, inflation and job gains and a resolution to the U.S. debt ceiling that clouded the global backdrop, the Bank at a minimum is seen suggesting it will hike in July when it gets more data and publishes new economic forecasts.

EXTREMELY HAWKISH TONE

“While the decision is a close call, the Bank will almost certainly take an extremely hawkish tone. If it opts for a hike, they’ll likely keep the door open for further moves,” BMO strategist Benjamin Reitzes wrote in a research note, who predicts the central bank will hike in July instead of this week.

Governor Tiff Macklem hiked eight times in a row through January and says policymakers are assessing whether they’ve done enough to ensure inflation slows to 3% by midyear and to target by the end of 2024. The BOC has a single mandate to keep inflation at 2% and it’s now 4.4% after a peak of 8.1% last June. (See MNI INTERVIEW: BOC Hike More Likely Near-Term Risk: McNeil)

Canada’s economy grew at a 3.1% annualized pace in Q1 – faster than the BOC’s 2.3% prediction -- and perhaps another 1% in Q2 based on a flash April figure. The last inflation report unexpectedly quickened to 4.4% from 4.3% in April while a jobs report showed wages up 5.2% and unemployment a sliver above record lows at 5%.

Inflation has exceeded target since March 2021, increasing the danger of sticky price gains. Bank surveys and private polls suggest consumers and firms doubt CPI is returning to target anytime soon.

HOUSING BOIL RETURNS

At the same time, the Bank's dramatic 100bp increase last July should be exerting its peak drag on the economy around now. Officials have said inflation risks are more balanced after the most aggressive rate hikes in decades though upside ones are more concerning. Any increase would take rates to the highest since 2001 when they reached 5.75%.

Former officials have told MNI disinflation so far is linked to the surge from the Ukraine war and Covid falling out of the 12-month inflation index, and that getting all the way back to 2% is harder. Canada’s real policy rate only recently turned positive against the current rate of CPI and some measures of inflation expectations.

Hiking now would also increase the policy divergence between the BOC and the Federal Reserve. More investors see the Fed pausing rate hikes at its June 14 announcement after the U.S. central bank kept hiking earlier this year while Macklem paused. BOC officials justified the pause saying inflation is lower in Canada and that they hiked earlier and more aggressively.

Judging the tightness of Canada’s economy is complicated with the biggest influx of immigrants in decades boosting labor supply and creating more demand, especially in a stretched housing market. Canadians have racked up debts now worth more than the nation's GDP, raising the risk that tighter policy will do more than just cool demand.

The IMF last week put Canada at the top of yet another list of risky global housing markets, and sales are gaining steam again since the Bank went on pause.