MNI STATE OF PLAY: BOC Seen Building Case For Hiking Sooner

The Bank of Canada will likely highlight strong inflation and Covid variant risks Wednesday and affirm conditions for raising the record low 0.25% interest rate may be in place by April as a growing number of investors doubt policy makers will be able to hold off until July.

Consumer spending is leading economic growth as Governor Tiff Macklem predicted and inflation is coming in well above the central bank's 2% target as projected in an October forecast. The statement due at 10am EST may also offer revised language on the pandemic given the recent emergence of the omicron variant, but that wouldn't alter rate hike bets given a strengthening economic backdrop.

Macklem has said the economy could return to full output with inflation stable around its 2% target in the "middle quarters" of next year, allowing for a rate increase. Some investors are betting on several hikes next year starting by April with 4.7% inflation that's the fastest since 2003 and the seventh month outside the target band. November's job surge also supports a faster rate liftoff.

“Pressure is building on policymakers to pull back stimulus, but uncertainties like Omicron continue to cloud the outlook. Still, given the strength in jobs and inflation, the risks are skewed toward an earlier start to Bank of Canada rate hikes,” BMO strategist Benjamin Reitzes wrote in a research note. National Bank Financial on Friday called for a rate hike by March.

PREVENTING EMBEDDED PRICE GAINS

Inflation hasn't topped 4.7% since 1991 when the Bank of Canada became the first G7 nation to adopt inflation targets, following only New Zealand. Its current five-year mandate lapses at the end of this month, and sources see an extension of the status quo. The adoption of targets saw inflation slide from well over 5% to about 1% by the middle of 1992, which could limit how much rates need to climb.

RBC projects inflation will average 2.5% in the fourth quarter of next year, adding pressure for the central bank to further back away from comments about transitory supply chain and energy costs driving price gains. Since the last decision, Macklem wrote in the Financial Times the central bank will react if needed to keep inflation under wraps, and shortly after that Deputy Larry Schembri said inflation is transitory.

"The Bank of Canada is committed to ensuring that price increases don't become ongoing inflation," Governor Tiff Macklem said in October at his first in-person press conference since the pandemic shutdown. The Bank will continue to adjust its policy settings if more inflation pressures emerge, he told reporters.

The opposition Conservative Party has stepped up attacks on the Liberal government and Macklem for loose fiscal and monetary policies boosting the cost of living, and urged them to quickly renew a commitment to the 2% inflation target without adding any new mandates such as inclusive employment or climate change. The BOC's October projections call for 4.8% inflation this quarter and boosted the 2022 projection by a full percentage point to 3.4%.

Canada's central bank shifted QE to a "reinvestment" phase at the last meeting in October -- holding the balance sheet around CAD500 billion or four times its pre-pandemic size -- and has said that stance will remain at least until it hikes interest rates. There's little sense in the market the BOC needs to mirror the Fed and move to a faster wind-down of asset buying, or to signal that recent flooding in British Columbia could derail the recovery.