June BoC Preview: It's Starting to Feel a Bit Hikey

We would make the following arguments ahead of the June BoC meeting:

1. Recent data have cleared the bar to additional hikes,
2. A one-and-done hike would accomplish little, and
3. Market pricing is a bit conservative.

Pulling those threads together, we look for the Bank to lift the overnight rate by 25bp in both June and July.

Dealing with these arguments in turn, we'd first note that the conditional pause in January was predicated on a substantially weaker forecast. The recent Q1/March GDP data sets up a substantively stronger outlook, where it is difficult to make the case for enough slack entering the economy to bring inflation back to 2.0% by the end of 2024. Looking at the job market, the unemployment rate has been stable for 5 months at 5.0%. Our previous view for the BoC to stay on hold at 4.50% for all of 2023 was predicated on a marked slowdown in activity in 2023H1. With the economy remaining resilient, we no longer see a compelling argument for the BoC to hold at 4.50% this year.

This feeds nicely into our second argument: the magnitude of the upside surprise on both growth and inflation probably warrants more than a 25bp move. Indeed, an improvement in the forecast that warrants only a slight adjustment in monetary policy probably wouldn't be enough to rouse the Governing Council from its pause. The BoC needs at least two hikes to get out of bed. And if the BoC were already debating further tightening in April, the combination of upside data surprises and subsiding U.S. banking pressures should push it further down the road to more tightening.

3m annualized core inflation is hanging stubbornly around 3.5%, and y/y inflation has been above 3.0% since April 2021. We don't think the BoC can afford to wait another quarter or two for signs of weakness to possibly materialize, and as such we think the more compelling argument is for the Bank is to lift rates immediately. This brings us to our third argument, which is that markets are underpricing near-term BoC hikes. It is entirely plausible that the Bank may be more comfortable waiting until it has the July MPR forecast in hand to support a policy rate change, so we'd argue that a 50-60% chance of a hike is appropriate pricing for June, versus ~40% today.

Moreover, even if the BoC holds in June, we would need to see a rapid change in economic fortunes to justify another hold in July. From that perspective, we think the September meeting should be trading closer to 5.00% (versus 4.79% today); while there is some probability that the BoC manages to avoid lifting rates at all this year, we need to balance that against the probability of three consecutive 25bp increases.

We expect a relatively hawkish statement with the Bank reiterating that the economy remains in excess demand. Inflation is still likely to fall sharply in the middle part of this year owing to base effects, but look for the communiqué to note that labour market activity needs to soften further for inflation to move back to 2.0% by the end of 2024. The forward-looking section from the Bank of Canada's April press release probably doesn't need to undergo substantive changes, as it was already open-ended with Governing Council stating that it “continues to assess whether monetary policy is sufficiently restrictive to relieve price pressures and remains prepared to raise the policy rate further if needed to return inflation to the 2% target.” We look for the Bank to repeat that line, along with the mission statement that Governing Council is committed to achieving the 2.0% inflation target.

The realized upside surprises on growth and inflation are large enough to warrant additional tightening, but we do still expect to see slower growth over the remainder of 2023. Rate hikes are not working quickly enough (e.g. Q1 household consumption at 5.7% SAAR), but there are signs of slower growth down the road. Disposable income dropped in Q1 due to falling transfer payments despite a sharp increase in employee compensation. With debt service ratios expected to rise further we would expect to see household spending retrench in the quarters ahead, so we do believe that 5.00% will represent the terminal rate for the BoC this cycle.

Looking further down the road, we view rate cuts as a conversation for 2024. We believe three things need to be true for the BoC to cut rates outside a tail risk scenario:

• First, growth needs to be below trend.
• Second, inflation needs to be below 3% y/y and with underlying CPI inflation at 2%.
• Third, the economy needs to be in excess supply. We think excess supply in Canada roughly equates to an unemployment rate in the high 5s or low 6s, and we think the labour market is the right lens to be using here given that this portion of the cycle is mostly categorized by labour market shortages.

We would put forward that the economy is unlikely to go clearly into excess supply in 2023, and further argue that we are unlikely to see low enough inflation to allow for modest easing until 2024H1. Consequently, we do not believe the BoC will be able to consider easing policy rates until 2024Q2.