September 06, 2023 | 10:36
BoC Policy Announcement: Back to Cool
The Bank of Canada opted to hold its key overnight policy rate steady at 5.0% in today's decision, following back-to-back 25 bps hikes in the prior two meetings. The result was no surprise, as markets and analysts were leaning heavily in the no-move direction. Accordingly, the main focus was on the messaging, and the overall tone was "just the facts", but explicitly leaving the door open for possible further moves. Policymakers clearly do not want a repeat of earlier this year, when a short-lived pause sparked thoughts of eventual rate cuts, in turn firing up housing.
In the Statement, the Bank notes that the global backdrop has softened—especially China—but inflation remains elevated. For the domestic economy, we have "entered a period of weaker growth", and the sag in Q2 GDP "is needed to relieve price pressures." Yet, despite a less-tight labour market, the BoC highlights that wage growth remains "around 4% to 5%".
Underlying inflation remains a clear issue for policymakers and this is where the Statement maintains a hawkish bias. While inflation has come down, the Bank looks for a near-term back-up due to energy prices (in line with our view). Core CPI and inflation expectations are the big concern, as core shows "little recent downward momentum in underlying inflation", and "the longer high inflation persists, the greater the risk that elevated inflation becomes entrenched, making it more difficult to restore price stability." These are the main two hawkish talking points. And, along with the probability that headline inflation is going to step up close to 4% again with oil prices rolling higher, these core concerns will keep the rhetoric hawkish for some time yet.
Inflation worries were reiterated in the final paragraph of the Statement, with a warning that the Bank is "prepared to increase the policy interest rate further if needed"—no 'pause' reference here. The final three sentences of the Statement, where the Bank discusses what will drive coming decisions, were the same as in July.
Bottom Line: The Bank has certainly left the door ajar to the possibility of more hikes, but unless growth rebounds in Q3—which we doubt—the BoC is likely done with rate hikes. The softer growth backdrop will bring inflation back to 2% over time in our view and in the BoC's models, even if the short-term CPI outlook is much more problematic. Holding rates steady at the next meeting will require some nerve as the next two CPI reports could see headline inflation approach 4% (the next one is due Sep/19), and will likely require still-chilly growth and some calming in core inflation.
Whither housing now? A fair question to pose now that the Bank has held steady is will the return to pause cause the housing sector to reignite, as it so vividly did this past spring? Robert Kavcic offered this answer today: "Probably a lot less so for at least three reasons: First, we're getting more new listings compared to the spring, when everyone seemed to be holding back (active listings are up 16% y/y, and not being absorbed nearly as fast). Second, there was meaningful mortgage rate relief in the spring [in part, due to the U.S. banking turmoil], especially in the shorter-term fixed space, which we're not seeing today given where yields are right now. Third, there has been some softening in the economy and job market conditions compared to early in the year. A BoC pause will surely help market psychology, but the headwinds looks stiffer."