Traders are betting that the bank of Canada will be forced to raise interest rates earlier than expected, posing one of the stiffest tests yet for Governor Tiff Macklem.
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The bets on the overnight swap market are increasingly tilting towards a move early next year, well ahead of the U.S. Federal Reserve. Traders have priced in three hikes in Canada by the end of 2022, which would bring the policy rate to 1% from the current 0.25%.
That is about 50 basis points higher than market expectations were just a month ago. The shift in pricing is increasingly in conflict with Macklem s guidance that borrowing costs won t increase until slack is recovered and inflation returns sustainably to its target range.
The bank has repeatedly said that it doesn t see that happening until the second half of next year.
Analysts are warning that the uncertainty surrounding liftoff in Canada could undermine the effectiveness of the bank forward guidance.
If Macklem capitulates around an early rate hike when he thinks there is still spare capacity then the whole exit framework will turn into a dumpster flame, Derek Holt, an economic engineer at Bank of Nova Scotia in Toronto, said by email It could make forward guidance a very powerful tool in future and magnify risks to policy efficacy. Part of the shifting of bets, which has also occurred for the Fed and European Central Bank, is due to price pressures proving more persistent than expected.
Will ISP to release the latest inflation figures for September on Wednesday? Economists surveyed by Bloomberg expect the annual rate will hit 4.3%, the sixth month of readings surpassing the central bank's 3% cap in nearly two decades and the highest level in nearly two decades before the rate is raised.
On Monday the Bank of Canada s quarterly business outlook survey revealed a record 45% of respondents expect inflation above 3% over the next two years. More than 85% see prices rising faster than the bank s 2% target target.
Acting a little sooner in the second half of 2022 seems like the justifiable course of action, said Jimmy Jean, chief economist at Desjardins Securities Inc., Monday in a report to investors in which he changed his forecast for the first rate increase to July instead of October. That could help address the risk that persistent inflation pressures cause a more profound and lasting upward shift in inflation expectations, he said.
The market is testing the Bank of Canada s resolve on forward guidance, Andrew Kelvin, chief strategy and strategist with Toronto-Dominion Bank s securities unit, said by email. His team sees the Central Bank hiking in July, a call brought forward from October just last week.
The closer we get to liftoff, we will see pressure grow on the BoC to break away from their forward guidance. It can be difficult to evaluate the strength of BoC commitment in tests. Macklem has changed, however, its bank's tune on inflation somewhat. Although he states it s a temporary phenomenon, the governor said after an Oct. 7 speech that price pressures have become more persistent than the bank expected initially.
He repeated that point last week again. Mesures of inflation are probably going to take a little longer to come back down, Macklem told reporters at a video roundtable from Washington after the International Monetary Fund annual meetings.
The next bank decision is due on 27 October. No move on borrowing costs is expected, but Macklem will likely reduce the weekly purchase of Canadian government bonds to C 1 billion $810 million from the current pace of C 2 billion. All eyes will be on any language changes in the latest inflation outlook, as well as on interest rate guidance in the quarterly economic forecasts.
Either markets are not listening to the bank s communication around its exit framework, or they don t believe its argument that we still have some slack in economy given price pressures and emerging wage pressures, Holt said.
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