Traders are betting that the Bank of Canada will be forced to raise interest rates sooner than expected, posing one of the stiffest tests yet for governor Tiff Macklem.
Bets on the overnight swaps market are significantly tilting toward a move in early next year, well ahead of the U.S. Federal Reserve. Traders have now priced in three hikes for Canada by the end of 2022, which would bring the policy rate to one per cent from the current 0.25 per cent.
That is about 50 basis point more than they had expected just a month ago. The shift in pricing is increasingly in tune with Macklem's guidance that borrowing costs won t increase until slack is absorbed and inflation returns sustainably to its target range.
The bank has stated repeatedly 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's forward guidance.
If Macklem capitulates around a rate hike when he thinks additional capacity might still exist then the whole exit structure will turn into a dumpster fire, Derek Holt, an economist at Bank of Nova Scotia in Toronto, told Macklem by email. It could make forward guidance a very weak tool in future and magnify risks to policy efficacy. Part of the shift in bets, which was also attributable to the Fed and European Central Bank, is due to price pressures that are more persistent than anticipated.
Statistics Canada is due to report inflation data for September on Wednesday. Economists surveyed by Bloomberg expect the yearly rate to hit 4.3 per cent, the sixth straight level in nearly two decades and the highest monthly readings below the central bank's three per cent cap.
On Monday, the Bank of Canada's quarterly business outlook survey revealed that a record 45 per cent of respondents anticipate inflation by another three per cent for the next two years. More than 85 per cent of all bank notes see prices rising faster than the two per cent target.
Acting a bit early in the second half of 2022 seems like the right course of action, said Jimmy Jean, chief economist at Desjardins Securities Inc., in a report to investors : 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 determination on forward guidance, Andrew Kelvin, chief trade strategist at Toronto-Dominion Bank's security unit, said by email. His team sees the central bank hike in July, a call raised from October just last week forward.
The closer we get to liftoff, the pressure on the BoC to break away from their forward guidance will increase. It can be difficult to evaluate the strength of BoC commitment. Macklem has, however, redesigned the bank's inflation rate somewhat. While he maintains it s a persistent phenomenon, the governor said that price pressures have become permanent more persistent than expected after an Oct. 7 speech.
He repeated this point again last week. How is the International Monetary Fund's inflation expected to come back down shortly, Macklem told reporters during a video roundtable from Washington after the annual meetings of the President.
The next decision should be due Oct. 27. The bank s next decision is due Oct. 27. No move on borrowing costs is expected, but Macklem will likely pare back the weekly purchase of Canadian government bonds to $1 billion from the current pace of $2 billion. All eyes will be on any changes in the language of rate guidance, as well as inflation outlook in quarterly economic forecasts.
Either markets are not listening to the bank's communications around its exit framework, or they don t believe its argument that we still have slack in the economy given price pressure and nascent wage pressures, Holt said.