July BoC Announcement: Go Big or Go Home
By: Andrew Kelvin, Robert Both, and Mazen Issa
July 11, 2022 - 4 Minutes 30 Seconds
Macro Overview
There is not much scope for nuance at the upcoming BoC meeting, where we look for a 75bp rate hike, pushing the policy rate to 2.25%. Policy is still accommodative, and the BoC has repeatedly stated that the economy is in excess demand. Inflation continues to push to new multi-decade highs, and recent surveys show evidence of inflation expectations becoming unanchored. If the economy is in fact in excess demand, policy rates need to move to restrictive territory as quickly as feasible.
In short, the only responsible thing for the Bank to do here is to lift rates by as much as markets will allow it to. A dovish surprise in July would deal a crippling blow the Bank's credibility, and would risk reinforcing the sharp move higher in inflation expectations. Consequently, we see a low probability of a 50bp hike this month.
In short, the only responsible thing for the Bank to do here is to lift rates by as much as markets will allow it to. A dovish surprise in July would deal a crippling blow the Bank's credibility, and would risk reinforcing the sharp move higher in inflation expectations. Consequently, we see a low probability of a 50bp hike this month.
Fortune Favours Bold Policy
We do think there is even an argument to be made for a 100bp hike. Our Taylor Rule calls for a BoC policy rate of more than 4.00% by the end of the current quarter, and it uses the BoC's published output gap measures as an input. Given that the Bank believes those indicators are overestimating the amount of slack in the economy, a prescriptive rate of 4.50% actually seems conservative. While a 100bp move would be a bold declaration of the Bank's commitment to taming inflation, we doubt that the Governing Council would be comfortable with such an aggressive move unless given an explicit green light by markets (the OIS curve currently incorporates 73 bps of tightening for the July meeting).
Concerns about growth slowing more quickly than expected are valid, but shouldn't have any bearing on the BoC's decision in July. Q2 growth is still likely to print above 4.0%, and inflation is expected to move higher again with the June release. Plunging consumer confidence and a sudden decline in house prices are both significant sources of concern, but the magnitude of the slowdown in 2022H2 matters more for determining the terminal rate. The Bank's immediate problem surrounds inflation expectations, which need to be crushed via front-loaded rate hikes. We look for 50bp hikes at both the September and October meetings, although the Business Outlook Survey clearly raises risks of a 75bp move in September.
Concerns about growth slowing more quickly than expected are valid, but shouldn't have any bearing on the BoC's decision in July. Q2 growth is still likely to print above 4.0%, and inflation is expected to move higher again with the June release. Plunging consumer confidence and a sudden decline in house prices are both significant sources of concern, but the magnitude of the slowdown in 2022H2 matters more for determining the terminal rate. The Bank's immediate problem surrounds inflation expectations, which need to be crushed via front-loaded rate hikes. We look for 50bp hikes at both the September and October meetings, although the Business Outlook Survey clearly raises risks of a 75bp move in September.
Doubling Down on Inflation Expectations
The communiqué and press conference ought to have a stridently hawkish tone. There is absolutely nothing to be gained by equivocating. We look for the BoC to reiterate that interest rates will need to rise further, and that it is prepared to act more forcefully if needed. We don't think the BoC would explicitly intend that comment to be seen as a signal of an incoming 100bp move, but there is absolutely no point in softening the message at this juncture.
Inflation concerns should be front and centre, and we expect the BoC to caution that inflation continues to broaden. We expect a faint note of alarm around inflation expectations, and we look for the Bank to reaffirm its commitment to use its policy tools to bring inflation (and inflation expectations) back under control. The description of Canadian growth should remain relatively optimistic, focusing on services consumption and business investment, though we look for it to note that housing activity has slowed markedly. The outlook for global growth is likely to be more cautious, however, given recent indications of slower growth in the US and Europe, with the BoC noting the impact of supply chain disruptions, the war in Ukraine, and high commodity prices.
Inflation concerns should be front and centre, and we expect the BoC to caution that inflation continues to broaden. We expect a faint note of alarm around inflation expectations, and we look for the Bank to reaffirm its commitment to use its policy tools to bring inflation (and inflation expectations) back under control. The description of Canadian growth should remain relatively optimistic, focusing on services consumption and business investment, though we look for it to note that housing activity has slowed markedly. The outlook for global growth is likely to be more cautious, however, given recent indications of slower growth in the US and Europe, with the BoC noting the impact of supply chain disruptions, the war in Ukraine, and high commodity prices.
Rates Market Implications
We expect only a minimal impact on rates markets, as a 75bp move is almost fully priced. The hawkish tone may push rates slightly higher in 2s through 5s as the hawkishness could push up pricing for the next 3-4 meetings on the margin — but Canada has been a passenger on recent moves in markets, and an on-consensus BoC meeting won't change that. Our highest conviction view continues to surround Canada-US spreads, as we think GoCs are cheap versus Treasuries at all tenors.
FX Market Implications
The CAD is between a rock and a hard place. The latest BOS showed that the BoC has an inflation expectations problem and that it will require a resolute stance to combat it. But the more aggressive the policy response, the faster the BoC front-loads or accelerates the inevitable pain facing overly indebted households
The OIS curve is already largely priced for a 75bp hike at this meeting and almost as much in September. So even if the BoC resorts to back-to-back 75bp hikes (or even surprises with 100bp now or in the future), we see it exacerbating the macro imbalance (as it relates to household leverage), which will have to show up in the CAD. With US CPI released on the same day as the BoC decision, and likely to be as strong as the last report that led to the Fed's 75bps hike, we continue to see upside risks to the USD. As such, we think we're likely to see USDCAD move toward 1.35 in the coming weeks. From a positioning/valuation point of view, the CAD looks over-loved still. Moreover, we think the outlook for risk sentiment remains challenged as the market is underestimating just how far the Fed is likely to hike.
The OIS curve is already largely priced for a 75bp hike at this meeting and almost as much in September. So even if the BoC resorts to back-to-back 75bp hikes (or even surprises with 100bp now or in the future), we see it exacerbating the macro imbalance (as it relates to household leverage), which will have to show up in the CAD. With US CPI released on the same day as the BoC decision, and likely to be as strong as the last report that led to the Fed's 75bps hike, we continue to see upside risks to the USD. As such, we think we're likely to see USDCAD move toward 1.35 in the coming weeks. From a positioning/valuation point of view, the CAD looks over-loved still. Moreover, we think the outlook for risk sentiment remains challenged as the market is underestimating just how far the Fed is likely to hike.
Director and Chief Canada Strategist, TD Securities
Director and Chief Canada Strategist, TD Securities
Director and Chief Canada Strategist, TD Securities
Vice President and Macro Strategist, TD Securities
Vice President and Macro Strategist, TD Securities
Vice President and Macro Strategist, TD Securities
Director and Senior FX Strategist, TD Securities
Director and Senior FX Strategist, TD Securities
Director and Senior FX Strategist, TD Securities