Thoughts

January 19, 2024 | 14:23

BoC Preview: Still More Work to Do

Economist

Managing Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal nearly two decades. He is re-sponsible for the Canadian macro-econom... (Read more)

Benjamin Reitzes

Managing Director, Canadian Rates & Macro Strategist
Fixed Income Strategy

Benjamin has been with the Bank of Montreal nearly two decades. He is re-sponsible for the Canadian macro-econom... (Read more)

The Bank of Canada makes its first policy announcement of 2024 on Wednesday January 24, with no change expected in the overnight rate for the fourth consecutive meeting. There have also been some rumblings about potential changes to quantitative tightening (QT), but we aren’t expecting any shifts on that front just yet either (though there’s an outside chance of a tweak). While the market continues to get excited by the potential for rate cuts, it’s far too early for the BoC to take a more dovish tone. We’re anticipating that the statement will be broadly similar to what was said in December. We’ll also get a Monetary Policy Report, which means fresh forecasts, and a press conference (which will now be held after every meeting in an effort to improve communication).

The likely starting point for all Governing Council deliberations is that inflation remains well above target. The latest CPI report was not encouraging, as the BoC’s chosen core CPI measures accelerated from any perspective. Both the Trim and Median core CPIs are in the mid-3% range, far from the 2% target, even if that’s well down from the 2022 highs. We continue to believe that policymakers will wait to see core inflation come down to the mid/high-2% range before rate cuts become a realistic option. Barring some extremely weak prints in the next couple of months, it’s tough to get into that ballpark until around mid-year.

Looking beyond the CPI figures, the BoC’s policy statement has highlighted excess demand, inflation expectations, wage growth and corporate pricing behaviour since June. While the economy is no longer in excess demand, the Q4 Business Outlook Survey (BOS) failed to show a further easing in capacity pressure. That’s despite the economy stagnating since January 2023. Inflation expectations cooled over the course of last year, but on the business side there was no improvement in the Q4 BOS, while the consumer side only ameliorated a touch. Wage growth remains well above levels consistent with the 2% target. And, corporate pricing behaviour has started to normalize, but isn’t yet in line with historical levels. There’s work to be done on all four fronts.

The updated forecasts will be worth watching as well. The October MPR was expecting modest GDP growth in Q3 and Q4. Huge revisions came with the Q3 report, creating some ambiguity. Indeed, while Q3 came in far weaker than anticipated at 1.1% annualized, the level of GDP was still materially higher due to revisions suggesting there was more excess demand in prior quarters than initially thought. BMO is forecasting GDP growth to stagnate in Q4 and 2024Q1, and the MPR will likely show a similarly soft profile. The BoC has already told us it expects the economy will remain weak into early 2024, so something around our call would be consistent with that narrative.

Key Takeaway: There’s no denying there’s been progress on bringing inflation lower; however, it’s also clear that there’s still plenty of work to do in order to get back to 2%. Rate cuts are very likely in 2024, but the Bank of Canada is going to remain as patient as possible for inflation and inflation expectations to retreat further. Following three years of well-above-target inflation, the last thing policymakers want to do is ease policy too early and allow inflation to re-accelerate.