October 26, 2022 | 11:06
Bank of Canada Rate Decision & MPR — Trying to Thread the Needle
The Bank of Canada surprised with a 50 bp rate hike, 25 bps less than expected, bringing policy rates up to 3.75%. There's no debating that 50 bps is still an aggressive move, but the Bank's decision not to deliver what the market was anticipating was driven by a meaningful downgrade to the economic outlook. The latter is expected to dampen inflation pressures sufficiently, prompting today's smaller move.
Inflation remains the prime concern for policymakers, but it's clear that the economy is taking an increasingly prominent role. Growth forecasts were cut across the board with 2023 global GDP growth cut to 1.6% from 2.0% previously. The Bank halved its Canadian GDP growth projection to 0.9% for next year, with the economy effectively stalling in the first half of the year. It's not quite a recession call; but, it's not far off either. "GDP growth is then projected to slow to between 0% and ½% through the end of 2022 and the first half of 2023. This suggests that a couple of quarters with growth slightly below zero is just as likely as a couple of quarters with small positive growth." Note that the BoC's forecast still looks on the rosy side, with BMO forecasting 0% GDP growth next year.
The inflation projections were trimmed as well, as the pullback in commodity prices since the July MPR have helped dampen headline price pressures. The Bank expects Q4 inflation to average 7.1% y/y, down from 7.5%. More importantly, and perhaps helping drive today's 50 bp move (instead of 75 bps), the 2023Q4 inflation forecast was cut four ticks to 2.8%. That puts headline inflation inside the 1%-to-3% control band by the end of next year.
Interestingly, there were no specific comments about the Canadian dollar despite Macklem's recent musings on the currency. The statement just had one sentence on the US$'s global inflationary impact. Clearly the Bank isn't that concerned about the C$'s inflationary impact at the moment. Perhaps rightly so, as the C$ quickly shook off initial weakness after the smaller-than-expected hike.
One potentially prickly point for policymakers is that a number of politicians have been weighing in on the policy decision in recent weeks, stating that large rate hikes aren't appropriate anymore. Expect plenty of chatter about potential political influence, whether real or perceived.
There were a few notable tweaks to the concluding paragraph. "The Governing Council expects that the policy interest rate will need to rise further. Future rate increases will be influenced by our assessments of how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding. Quantitative tightening is complementing increases in the policy rate." The Bank is clearly stating that more hikes are coming, and the word "increases" suggests it won't just be one more hike and done. Policymakers will keep their options open to adjust rates as the inflation outlook shifts (or doesn't). We continue to have another 25 bps pencilled in for December, and are adding an additional 25 bps in January, keeping our call for terminal rates at 4.25%.
Key Takeaway: The Bank of Canada surprised markets, but a weakening economic backdrop suggests this ultimately could be the right move. Unfortunately, inflation is still red-hot and has shown no real signs of cooling yet. That's the fine balance the BoC is trying to achieve, threading the needle of taming inflation while not putting too much pressure on the economy. Today's decision puts a bit more emphasis on the economy. Hopefully that doesn't come back to haunt them in 2023 if inflation remains stickier than expected.