MNI STATE OF PLAY:BOC Seen Hiking Rate, Slimming Balance Sheet

The Bank of Canada will likely raise interest rates for the first time in more than three years on Wednesday to rein in the fastest price gains since adopting inflation targeting, and signal a balance sheet unwind as assets mature.

All 20 economists surveyed by MNI see the record low 0.25% benchmark lifted a quarter-point. Many say the Bank will either move straight to asset roll-off or signal that will start in April. The decision is due at 10am EST and there is no press conference or updated economic forecast paper.

Inflation quickened in January to the fastest since 1991 at 5.1% and conflict in Ukraine adds further near-term upside pressure as global oil prices keep rising. Policymakers have already been humbled by inflation after earlier signaling they could wait until the second half of this year to hike rates.

Governor Tiff Macklem says a shift is needed to a "path" of increases and balance sheet tightening would come at or after the first hike, though he surprised some investors at the last meeting in January by holding rates amid the omicron Covid wave.

TWO-SIDED RISKS

Russia's invasion of Ukraine adds uncertainty but there isn't a clear link that derails Canada tightening, said University of Ottawa emeritus professor Marc Lavoie, who's written dozens of papers and books on the Bank and correctly anticipated it would put focus on employment in last year's mandate renewal.

“They are going to raise interest rates because they want to send a message that yes we are concerned about inflation,” he said. “I would be surprised if they make a strong move” like a 50bp hike or aggressive balance-sheet reduction, he said.

Swaps trading shows some investors making bets on a 50bp hike after Deputy Tim Lane's Feb. 16 speech saying policy could be "forceful" if needed. Macklem last year downplayed the potential for a half-point hike when asked by MNI about it at a press conference, reminding that the downturn was sharp and swift and the recovery hesitant. The BOC made three 50bp rate cuts in March 2020 as the pandemic emerged.

Canada hasn’t hiked since October 2018 when the benchmark reached 1.75%, and most economists see four hikes this year. Sources have told MNI the path can't be aggressive in returning rates towards neutral because indebted consumers are more vulnerable than in past cycles. Big hikes would also conflict with a government pressing ahead with fiscal stimulus even in an economy that's recovered jobs and output lost in the pandemic.

INFLATION ON FIRE

The Bank's Governing Council sees inflation holding around 5% in the first half of the year and moving towards 3% by yearend, the top of its 1%-3% target band. The Bank's own survey of executives shows CPI topping 3% over the next two years and business groups also report record views on price and wage gains.

“Inflation is well above the BoC’s 2% target, the output gap is more or less closed, and the housing market is on fire, all reinforcing the necessity of higher rates to keep inflation from accelerating,” BMO’s Benjamin Reitzes wrote in a research note Monday.

There's less clarity around the balance sheet. Macklem said Feb. 9 he will restore a more normal size after lifting rates, declining to say if he can go further than other central banks that failed to unwind QE after the 2008 crisis. Canada avoided QE then but during the pandemic was more aggressive, buying up almost half of federal bonds.