Has monetary tightening begun?
TD SECURITIES DATAFLASH
CA: Bank of Canada Shifts Into First Gear
- The Bank of Canada hiked its target for the overnight rate by 25bps, from 0.25% to 0.50%
- The forward-looking statement is quite tentative, indicating that although the default assumption is further hikes, a notable element of uncertainty remains.
- The key phrases in the report are “increasingly uneven”, “variability”, and “considerable uncertainty” – nothing is certain about the future.
The Bank of Canada lived up to tentative market expectations by delivering on a 25 basis point rate hike today, raising the overnight rate from just 0.25% to 0.50%. Of course, there was never anything certain about this, and the text of the statement bears no resembling to the prior one, revealing the tensions underlying the decision. The Canadian economy remains “robust”, and is “unfolding largely as expected”, both for GDP and inflation. Looking purely at domestic fundamentals, a strong case can be made not just for hiking but for outright monetary mountain climbing. However, global risks are weighing unusually heavily on the mind of the Bank of Canada, with particular emphasis on “renewed weakness” and “renewed tensions” in Europe. As a result, the true theme of this statement is one of uncertainty: the global recovery is “increasingly uneven”, “deleveraging will add to the variability”, and future actions have “considerable uncertainty”.
On the subject of future Bank of Canada decisions, we believe that a July 20th rate hike is significantly more likely than not, but the Bank’s forward-looking statement is designed to impart a high level of uncertainty: “Given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments.” The bottom line is that we remain very much in a data and event dependent mode, as was the case for the past month. The difference is that with a first rate hike under its belt, “this decision still leaves considerable monetary stimulus in place”, and so the automatic assumption shifts very clearly towards additional hikes. In the early stages of the last Bank of Canada tightening cycle, no forward-looking statements were offered whatsoever, so this is not unprecedented.
The conditional commitment that the Bank abandoned in April merited no mention in this latest statement, nor did the Canadian dollar. The loonie’s absence is not entirely surprising, as the Canadian dollar is behaving reasonably given global developments, and remains only a few cents softer than the Bank’s assumed USDCAD 1.01 level.
Once again, the balance of risks is not formally characterized in the Bank’s statement, and this is likely done by design to suggest a balance not horribly far from even. However, it is notable that the Bank acknowledges that more rapid fiscal tightening – one of the Bank’s formal downside risks – is likely to proceed. In turn, the risks have perhaps tilted slightly downward, whether the Bank admits it or not.
The bottom line is that the Canadian period of monetary tightening has begun. Barring significant negative developments either domestically or globally, we expect a July 20th rate hike, and further cautious rate increases at subsequent decisions. What is clear is that despite the ultra-low level of the overnight rate, the present environment is not one conducive to outsized rate hikes of the 50bps or larger variety. These have always been rare during tightening cycles, and will be doubly so this time around.