October 27, 2021 | 11:13
It's the End of QE as We Know It...and Rate Hikes are Nigh
The highly anticipated Bank of Canada meeting landed squarely on the hawkish side of expectations, clearly setting the table for interest rate hikes sooner than most had expected just a few short weeks ago. The key overnight lending rate was again held at 0.25%, but almost every other aspect of the release was a fire-breathing blast of concern on the inflation backdrop. The Bank flatly stated that QE was ending, and they looked for an earlier closing of the output gap, even as growth was downgraded this year and next. Perhaps the most eye-popping change in their forecast was a full 1 percentage point hike in expected average inflation in 2022 to 3.4% (basically lifting their call in line with ours). Perhaps the single biggest surprise was the tweak in their forward guidance, with the Bank now saying conditions for rate hikes may be in place by the middle quarters of next year, rather than the second half of next year. Among the many moving parts in today's announcement, and their latest quarterly Monetary Policy Report, here's what stood out to us:
Overall, the tone of the statement and the MPR landed squarely on the hawkish side of the ledger, leaving the Bank with plenty of flexibility to respond rapidly in the event of extreme outcomes (such as inflation rising even more rapidly). One point on the near-term economic forecasts is that the Bank is now at the high end with a call of 5.5% GDP growth in Q3 and inflation at 4.8% in Q4—those are high hurdles, suggesting it would take a big surprise to bring rate hikes even further forward.
Bottom Line: The Bank of Canada has taken a hard turn amid ramped-up inflation concerns, and even amid a milder growth backdrop. Along with the quick end to QE and their view of a mid-2022 return to potential, we now expect the Bank to begin hiking in mid-2022 (pulled forward three months), and continue raising rates at a 25 bp-per-quarter cadence. For now, we would assume that rate hikes progress quarterly until late 2023, bringing the overnight rate back in line with pre-pandemic levels two years hence. Clearly, the risks are tilted to an even earlier move, and—yes—the possibility of a faster cadence, and a higher end point. The key will be how inflation unfolds in the coming six months, and we are not far away from the Bank's new assumptions. But with employment back to pre-pandemic levels, housing prices still raging, equities at an all-time high, and inflation at almost a two-decade high, the Bank's sudden hawkish shift seems entirely appropriate.