BoC rate decision preview: Don't pause until you see the whites of their eyes

By: Andrew Kelvin, Mark McCormick, Robert Both, Chris Whelan

May 27, 2022 - 5 Minutes
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We expect the Bank of Canada to deliver a 50bp hike in June, lifting the overnight rate to 1.50%. This would mark the second consecutive 50bp move from the BoC, and we look for an additional 50bp move in July.

There had been speculation that the BoC would consider lifting rates by more than 50 bps this meeting, but BoC Governor Macklem pushed back against that idea in Parliament and the Senate. For their part, markets view a 50bp hike in June as a virtual lock (51bps of tightening are priced in). With little uncertainty around the decision itself, the focus will shift to the policy statement where we expect a hawkish tone. The BoC will note that growth and inflation are both tracking above the April MPR and repeat that rates will need to rise further.

So many moving parts

There may be a high degree of certainty around the size of the next BoC move, but the focus of the communiqué is more uncertain. The domestic economy is caught in a tug-of-war between several strong fundamental factors and the destructive impacts of high inflation and interest rates. For the moment we expect the BoC will focus on the upside surprises to growth and inflation:

  • The BoC has argued that the economy was moving into excess demand, and the big positive surprise on Q1 GDP growth (the April MPR looked for 3.0% SAAR, while flash estimates point to something in the mid-5s) will only exacerbate capacity pressures. We look for the BoC to maintain an optimistic outlook for services consumption and business investment.
  • With inflation running at close to 7.0%, the BoC will feel pressure to show that it is taking the inflation shock seriously. If the BoC spends too much time focusing on the headwinds facing the economy, markets may come to believe that the Bank is unwilling to bring inflation under control, causing expectations to become unanchored and requiring a more painful tightening cycle.
  • It also bears mentioning that high energy prices are still a modest net positive for the Canadian economy.


    • At the same time, we are troubled by the rapid deterioration in consumer confidence metrics, with the Bloomberg/Nanos Economic Confidence Index falling to its lowest level since late 2020. Prior to the pandemic, the index last reached these levels in March 2016. If household sentiment continues to deteriorate, the services rebound may be relatively tepid and remaining excess savings would become permanent. Moreover, even under relatively benign conditions, the BoC's forecast for 2023 growth looks highly optimistic given high household debt levels.

    High conviction until it's not

    We'd make two broad points here: first, a hawkish tone in June should not be an indication that the BoC will remain hawkish in any future meeting. Second, we look for the BoC to hike until something breaks. At some point, growth will slow notably, and as long inflation expectations remain well-anchored, we expect that to mark the high point for this tightening cycle. But until then, markets should be prepared for a string of rate rises.

    Looking forward, the BoC has repeatedly stated that it intends to move quickly back to the neutral. As such, we have high conviction that the BoC will lift rates by 50bps again in July, bringing rates to 2.00%, which is the low end of its range of estimates for the neutral rate. At that point, we expect the BoC to slow the pace of tightening to 25bp increments, and to revert to a more explicitly data-dependent approach. We look for the BoC to maintain a broadly hawkish tone until at least October, before "pausing" at 3.00% in January 2023 and preparing for cuts in early 2024. However, if our growth forecast for the middle-quarters of 2022 is too optimistic, it follows that the BoC will fall short of that 3.00% threshold.

    FX market implications

    The BoC is just one piece of the puzzle for the loonie. Arguably, the more critical driver rests on the global side, where risk sentiment (and the broad USD) maintain their market grip. As a result, we don't think the expected 50bp BoC hike will offer much excitement for markets, especially as USD/CAD sits close to our high-frequency fair value estimates of 1.28.

    That said, the global backdrop makes CAD more interesting on the crosses, which we expect to underperform NOK and AUD. The rub for CAD is that it is currently trading like a baby version of the USD, pulling along some negative factors as well. As a result, our Macro Ranking Scorecard Index model remain short CAD, underscoring negative signals in several factors like equities, risk, the yield curve, and inflation.

    We think the most important driver is that CAD is the most overbought G10 currency on our dashboard, leaving it vulnerable to a shift in the market narrative. In other words, if the USD falls, then CAD is likely to follow, especially on the crosses. That setup would likely limit the extent of USD/CAD downside, though, where we think the pair will probably hold the 1.26-1.30 range through the summer.

    Rates market implications

    A 50bp move in June is a strong enough consensus view that we do not expect significant moves in rates markets following the announcement. If the tone is as hawkish as we expect it to be, we may see modest selling in the very front-end of the curve given lingering concerns around the impact of higher rates from some market participants, but we expect little change for 5s through 30s. We would note that if we do see CAD 2-year rates move higher, it would present an attractive entry point to own CAD 2s versus the USD. We remain biased to see CAD outperform versus the USD in 10s and 30s, but BoC policy does not play much role in that view.

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    Headshot of Andrew Kelvin

    Andrew Kelvin
    Director and Chief Canada Strategist, TD Securities

    Headshot of Andrew Kelvin

    Andrew Kelvin
    Director and Chief Canada Strategist, TD Securities

    Headshot of Andrew Kelvin

    Andrew Kelvin
    Director and Chief Canada Strategist, TD Securities

    Andrew contributes to our firm's economic commentary and provides advice on developments in government debt markets. Prior to joining our firm, he spent four years working at the Bank of Canada in the International and Financial Markets Departments where he was responsible for analysis and forecasts on the U.S. economy, including coverage on market developments.

    Headshot of Mark McCormick

    Mark McCormick
    Director and Global Head of FX Strategy, TD Securities

    Headshot of Mark McCormick

    Mark McCormick
    Director and Global Head of FX Strategy, TD Securities

    Headshot of Mark McCormick

    Mark McCormick
    Director and Global Head of FX Strategy, TD Securities

    Mark helps to manage the bank’s research efforts for the major foreign exchange markets, along with developing the analytical framework used for market analysis, forecasts and trade ideas across different asset classes. Before joining the bank, he worked as a Global Macro Strategist at Credit Agricole Corporate and Investment Bank in New York.

    Headshot of Robert Both

    Robert Both
    Vice President and Macro Strategist, TD Securities

    Headshot of Robert Both

    Robert Both
    Vice President and Macro Strategist, TD Securities

    Headshot of Robert Both

    Robert Both
    Vice President and Macro Strategist, TD Securities

    Robert provides research and analysis on the Canadian economy and financial markets to a wide range of commercial and institutional clients. Robert joined TD Securities in 2015.

    Headshot of Chris Whelan

    Chris Whelan
    Director and Senior Rates Strategist, TD Securities

    Headshot of Chris Whelan

    Chris Whelan
    Director and Senior Rates Strategist, TD Securities

    Headshot of Chris Whelan

    Chris Whelan
    Director and Senior Rates Strategist, TD Securities

    Chris applies quantitative and fundamental frameworks when assessing domestic and cross-market opportunities in Canadian rates across both federal and provincial bonds and swaps. Chris joined TD Securities in 2019.

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