Market Wire - Bank of Canada Outpaces Fed with 100-Basis Point Hike, Loonie Jumps
The Bank of Canada lifted its benchmark rate to 2.5 percent in a single 100 basis-point move this morning, outrunning the Federal Reserve in tightening policy at the fastest pace since 1998. In the statement accompanying the decision, the central bank called inflation “higher and more persistent” than expected in April, with consumer prices likely to run at an 8 percent annualized rate in the “next few months”. Policymakers pointed to global factors like the war in Ukraine and supply chain disruptions as playing the biggest role, but also noted “domestic price pressures from excess demand are becoming more prominent”.
Fear of an unmooring in inflation expectations was evident throughout the release, with officials noting “surveys indicate more consumers and businesses are expecting inflation to be higher for longer, raising the risk that elevated inflation becomes entrenched in price- and wage-setting”, implying that “the economic cost of restoring price stability will be higher”.
Although the statement suggested the Bank sought to “front-load” rate increases, policymakers also signalled more tightening to come, again including a sentence saying “interest rates will need to rise further”. Markets expect the Bank to hike by another 50 basis points in September, with back-to-back moves coming at meetings through the rest of the year as policymakers work to bring rates closer to neutral territory.
As expected, the Bank raised inflation forecasts and lowered growth expectations. According to the accompanying Monetary Policy Report, price growth is expected to hit 7.5 percent this year - up from 4.5 percent in the prior projection - before slipping to 3.2 percent in 2023. Growth is seen slowing sharply, from 3.5 percent in 2022 to 1.75 percent next year.
The Canadian dollar shot upward in the minutes after the decision. Most traders were looking for a more dovish 75 basis point hike, but currency markets are also responding to a sharp rise in US rate expectations after this morning’s much hotter-than-anticipated inflation report drove a surge in short-term yields. Markets are currently putting 55 percent odds on a 75 basis-point move at the Fed’s July meeting, and 45 percent odds on a 100-point hike.
We suspect today’s Bank of Canada decision will serve to anchor US and global expectations even higher, partially nullifying the impact on the Canadian dollar exchange rate.