The Bank of Canada is one of the few central banks still balancing between hiking and cutting. Although the consensus is pretty strong that the upcoming meeting will end without any policy changes, the uncertainty does imply more volatility for the market. Even without an outright change to the interest rate, potential indications of a more solid direction for the BOC could push the CAD in either direction.
The BOC has been insistent that it is still open to raising rates. That’s after pausing earlier than most central banks only to see CPI bounce back up. And inflation has still stayed above target since then. While the Fed has moved decidedly to hold-unti-it’s-time-to-cut, the BOC’s overeagerness to cut last year has left it vulnerable to a flare-up in inflation. But, with the economy also showing signs of slowing, it’s now in a somewhat awkward position. That makes forecasting future Canadian rates harder, and consequently the market could react stronger to what the BOC does (or decides not to do).
Matching Expectations with Reality
While the BOC so far has been loath to give up the “can still hike if needed” talking point, markets have already shifted to looking to when a cut will happen. The recent datasets point to a softening of the Canadian economy, so it might be time for the BOC to finally come around to agreeing that the next move will be to the downside. But, that is likely to come with a lot of caveats, and insistence that rates will stay high for longer
At the moment, futures are pricing in rate cuts starting in April. That mirrors expectations for Canada’s southern neighbor, where Fed futures price in cuts starting with the second quarter. If the Fed moves towards easing, then the BOC will be under increasing pressure to at least follow suit.
It’s Not If, It’s When
The most recent BOC survey of businesses to track their outlook showed that a majority of firms say they have been negatively impacted by high interest rates. Those firms are also saying they are not planning any new hiring and see less favorable business conditions going forward. In other words, the BOC’s own data suggests that its high rates are starting to hurt the economy. If the Canadian economy were to seriously slow down, then BOC could get the blame, and moving away from a hawkish stance would help avoid that.
On the other hand, if the economy is slowing, then that means inflation will likely come down. The majority of analysts believe that inflation will fall to target faster than the BOC’s projections. That is, the analysts see inflation falling to 2% in the second quarter, while the BOC talks about “by the end of the year”. At that point, rate cuts would be seen as the most likely outcome.
What the BOC Could do Instead
Without changing rates, the BOC could send signals to the market that it’s moving away from tightening. One of the major issues is what will happen with quantitative tightening. Typically, central banks move to end QT before they move to hiking. The BOC could provide some forward guidance on its QT program.
Another, more subtle, way of moving away from hiking would be a tweak in forward projections, and talking about inflation coming down to target sooner than anticipated. That would allow for still saying that a rate hike is possible as necessary, but plant the suggestion that a pivot to easing is not far off. All of these options could end up weakening the CAD.
