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Market Wire: Bank of Canada Delivers Smaller-Than-Expected 50 Basis Point Hike, Loonie Tumbles

The Bank of Canada lifted its benchmark overnight rate to 3.75 percent this morning, disappointing Canadian dollar bulls who had expected a 75-basis point move. In the statement accompanying the decision, the central bank said “the economy continues to operate in excess demand and labour markets remain tight” but warned, “The effects of recent policy rate increases by the Bank are becoming evident in interest-sensitive areas of the economy: housing activity has retreated sharply, and spending by households and businesses is softening. Also, the slowdown in international demand is beginning to weigh on exports.”

As expected, the Bank lowered growth expectations, saying the economy is now “expected to stall through the end of this year and the first half of next year as the effects of higher interest rates spread through the economy”. According to the accompanying Monetary Policy Report, gross domestic product growth is seen slowing sharply – from 3.25 percent this year to less than 1 percent in 2023, before recovering to just below long-term trend levels in 2024.

Inflation fears eased somewhat, with year-over-year price growth projected to fall to around about 3 percent by the end of next year, hitting target by the end of 2024.

But “The Bank’s preferred measures of core inflation are not yet showing meaningful evidence that underlying price pressures are easing. Near-term inflation expectations remain high, increasing the risk that elevated inflation becomes entrenched”. Ahead of the decision, September’s inflation data showed headline prices rising 6.9 percent year over year, and the benchmark preferred by policymakers – an average of three core measures – climbing 5.3 percent, well above the Bank’s 2-percent target.

And according to the Bank’s own third-quarter Business Outlook Survey published last week, most Canadian firms expect sales to weaken and inflation to remain above the Bank’s target in the year ahead – even as commodity prices slump and wage pressures ease. The accompanying Survey of Consumer Expectations exhibited similar views on inflation, with most respondents saying they expect a recession to hit in the coming year.

Officials signalled more tightening to come, saying, “The Governing Council expects that the policy rate will need to rise further” – with markets betting the Bank will push overnight rates into “neutral” territory – around 4.5 percent – by year end.

The Canadian dollar moved slightly lower in the moments after the decision. Most traders were looking for a 75 basis point hike, but directional positioning was relatively minimal, resulting in a relatively-muted reaction. Longer-term rates continue to point to persistent underperformance: Canadian two-year yields are almost 30 basis points lower than their US equivalents, and the ten year spread favours the US by 60 basis points.

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