MNI STATE OF PLAY: Bank of Canada Seen Hiking 50BP, Framing QT

Canada's central bank will likely raise its key lending rate by half a percentage point to 1% on Wednesday with inflation expected to stick above 3% for the next two years, and may also start allowing maturing assets to roll of the balance sheet.

The Bank of Canada's 0.5% overnight target will climb 50bp according to 16 economists surveyed by MNI, with two others seeing a 25bp move. The announcement at 10am EST from Ottawa also comes with an updated economic forecast and a press conference an hour later.

Following a quarter point hike from a record low 0.25% last month, Governor Tiff Macklem said he wouldn't rule out a bigger hike if the situation demanded. Since then the Bank's own survey showed a record 70% of firms expect inflation to top 3% and consumers see inflation at 4.6% in two years. Deputy Governor Sharon Kozicki in the Bank's last speech said policymakers will act "forcefully" if needed and that they would debate larger rate hikes and QT, though that phrase was also used before the March hike.

A big focus for investors will be whether the BOC signals another half-point move at the next meeting June 1, an outlook held by about a third of economists. Macklem may revise his view that a steady "path" of tightening is needed, perhaps in favor of something more aggressive or which gives him more room for maneuver. The Bank will also overhaul forecasts from January before Russia's invasion of Ukraine sent commodity prices soaring, adding to inflation already projected at 4.2% this year and 2.3% in 2023, while also potentially denting Canada's growth on weaker global demand.

The Bank sets rates to keep inflation in the middle of a 1%-3% band and return to target within two years.

BALANCE SHEET UNWIND

The balance sheet for months has been held at around CAD500 billion after growing to CAD575 billion from CAD125 billion under Canada's first QE program. Most economists see a shift to allowing maturing assets to roll off either immediately or in the near term, a move Macklem has said would a balance sheet decline of about 40% within two years, a pace he calls rapid.

There has been less speculation about whether the Bank might cap monthly maturities like the Fed or average them out over time. One expert has told MNI the BOC needs to consider outright sales, though economists see this as unlikely.

QE calmed markets after the global “dash for cash” but lowered yields less than a regular rate cut. It was criticized for putting the Bank on a path to owning half of federal bonds before tapering as the economy rebounded, and opposition lawmakers say it facilitated inflationary deficits.

Former Governor David Dodge has told MNI the BOC must hike rates to a neutral level just over 2% in a hurry as inflation tests public confidence. The job is made more difficult by Thursday's federal budget extending deficits and spending on things business groups say will boost inflation and consumption.

The BOC hasn't hiked 50bps since 2000, just before Dodge took office, though it cut three times by 50bp in March 2020 as the pandemic emerged.

Canada's economy has since regained pre-pandemic GDP and employment and restored full output. Inflation reached 5.7% in February, the fastest since 1991 when the Bank adopted inflation targets. The BOC in January predicted inflation holding around 5% in the first half of the year and moving towards 3% by yearend.