Bank of Canada expected to resist investor expectations of early rate hike

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Bank of Canada expected to resist investor expectations of early rate hike
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Economy15 hours ago (Mar 08, 2021 10:50AM ET)

Bank of Canada expected to resist investor expectations of early rate hike
© Reuters. FILE PHOTO: A sign is pictured outside the Bank of Canada building in Ottawa

By Fergal Smith

TORONTO (Reuters) – Investors see rising chances that the Bank of Canada would hike interest rates next year as the economic outlook improves, but the central bank is likely to push back against those bets for now, pointing to still high unemployment, analysts say.

The BoC has signaled that interest rates will stay at a record low of 0.25% until 2023, when it expects the economy to reach its potential. That is an unusual level of forward guidance, aiming to reduce uncertainty for borrowers during the coronavirus crisis.

Expectations for earlier hikes, after data last week showed the economy growing at an annualized rate of 9.6% in the fourth quarter, double the pace the BoC projected, could tighten financial conditions prematurely by raising borrowing costs and boosting the Canadian dollar, analysts say.

Tighter financial conditions could work against economic recovery. The bank is due to make an interest rate decision on Wednesday.

“They have to acknowledge that the outlook is better,” said Andrew Kelvin, chief Canada strategist at TD Securities. “At the same time they don’t want to encourage runaway expectations for near-term rate hikes.”

Money markets see about 40 basis points of tightening by the end of 2022, up from 10 basis points in mid-February. Longer-term rates have also moved higher, contributing to a rise in mortgage rates for the first time since January 2020.

FOCUS ON JOBS

In contrast, the market sees much less chance of the Federal Reserve raising rates next year despite the improving economic outlook in the United States, as it plans to allow inflation to run hot for a period to make up for past shortfalls.

A red-hot housing market, a surge in the price of oil, one of Canada’s major exports, and progress on U.S. fiscal stimulus have bolstered Canada’s growth outlook in recent weeks. Still, the BoC is likely to say that a complete recovery in the labor market will take time, risking long-term damage to the economy, analysts say.

Canadian employment remains 4.5% below pre-pandemic levels. By focusing on jobs, the bank would signal “they are willing to provide stimulus longer than they would of in past cycles,” Kelvin said.

The BoC’s widely flagged reduction of bond purchases could wait until at least April, when the bank will produce new economic forecasts, analysts say. Those projections could be accompanied by a raised estimate of potential output, or the level of activity that the economy can sustain without generating inflation, reducing the urgency to raise rates as the economy recovers, analysts say.

The BoC has estimated potential output growth at 1.4% per year, weighed by the pandemic’s scarring of the economy.

“We think the Bank (of Canada) will view recent developments as market pricing going too far, too soon,” Stephen Brown, senior Canada economist at Capital Economics, said in a note.

It is likely “to double-down on its commitment to keep the policy rate unchanged for a prolonged period,” Brown said.

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