MNI STATE OF PLAY: BOC Seen Hiking 75BPS To Grow Fed Gap

Canada will deliver another hefty rate increase Wednesday to further widen the gap over G7 peers, with most economists seeing three-quarters of a point as domestic demand stays resilient against stalling global growth.

The 2.5% overnight rate is seen rising to 3.25% by 15 economists surveyed by MNI with another five saying it will climb to just 3%. Either move would be less than the "front-load" July 13 hike of 100bps, with a few economists and former advisers saying a repeat of that move cannot be ruled out. Futures markets have fully priced in a 75bp increase.

Canada's economy grew at a 3.3% annualized pace in the second quarter while the U.S. and China stumbled, giving Governor Tiff Macklem more scope to keep tightening. Inflation remains almost four times the Bank of Canada's 2% target and Macklem took the rare step after the last CPI report of writing an opinion piece saying his job is nowhere near done.

The Bank's overnight rate has climbed from a record low 0.25% this year and officials say they must go further with inflation set to exceed the target for an extended period. Canada already faces wage-driven price increases that will take time to slow, a prominent industry lobby group economist who hosted Macklem in July has told MNI.

FUZZY NEUTRAL GUIDEPOST

Divisions over the size of the rate hike center around whether a wage-price spiral is brewing, how much money saved up during Covid shutdowns is left for households to spend, and whether a weak global economy drags Canada down. One former top government economist told MNI the Bank must move by at least another 75bps to prevent inflation from feeding wage demands. (See MNI INTERVIEW: BOC Must Remain Aggressive On Rate Hikes- Cross) Another former adviser told MNI the next hike could be just 50bps.

Macklem told reporters in July there's a case for hiking a bit beyond the 2%-3% neutral range, and even a 50bp move will take him to that threshold. Since then Fed Chair Jerome Powell said the neutral rate is no longer a solid guidepost given the level of inflation, and the Bank's one-page statement will be scrutinized for similar language. Macklem could also echo signals around `higher for longer' rates or flesh out a potential peak in this hiking cycle.

Raising Canada's key rate to 3% or 3.25% would take it to the highest since mid-2008, though still below the 4.25% rate that was in pace at the start of that year. Any hike will further widen the gap with the fed funds rate of 2.25-2.5%.

FOREIGN HAWKS

Most recent data suggesting a Canadian slowdown has been coupled with evidence inflation still rages. While a flash estimate alongside the second-quarter GDP report showed output shrank 0.1% in July, economy-wide prices rose the fastest since 1974, prompting several economists to raise their forecasts for a hike to 75bp

Consumer price inflation slowed to 7.6% in July from 8.1% in June, the fastest since January 1983, but many investors paid more attention to core rates averaging a record 5.3%. The Bank's July projection said inflation may stay at around 8% for a few months and exceed the 2% target until the end of 2024, longer than its two-year horizon for restoring normalcy.

Investors see little chance the Bank will take more aggressive steps to slim its balance sheet beyond the current stance of allowing maturing assets to roll off. The Bank's assets grew to CAD575 billion from CAD125 billion during the pandemic and Macklem has said the current posture reduces the balance sheet 40% over two years.

Canada's decision Wednesday could set up a month of hawkish meetings. Some ECB officials ahead of their decision Thursday have signaled they would like to see a 75bp move, the BOE has a decision the following week and the U.S. and Japan meet later this month.