Today’s Bank of Canada policy decision was expected to be a formality for markets after Governor Macklem downplayed the chance of a 75bp move back in late April and all economic data since the April 13 meeting pointed toward a successive 50bp increase.
While the BoC met market expectations and raised rates by 50bp to 1.5%, the accompanying statement proved more hawkish as the BoC laid the foundations for its own “expeditious” move towards neutral rates. Not only does this bring about the question of more 50bp hikes, and potentially even 75bps should inflation prove more resilient to higher rates, but it also brings into question the market’s current perceived terminal rate for the BoC, which currently sits just shy of 3.4%.
When discussing current inflation conditions, the Bank is now viewing the broadening of domestic price pressures and the consistently above-target inflation prints as a major risk to de-anchoring inflation expectations. In the Bank’s own words, the “risk of elevated inflation becoming more entrenched has risen”.
Meanwhile, towards the back-end of the statement, the Bank’s more pressing language with regards to the path of rates will likely spark speculation over an “expedited” move to the neutral range, not dissimilar to the path laid out by the Fed. In essence, the Bank may have just laid the foundations for further 50bp moves in the coming meetings, with a highly “unusual” 75bp move now back in question should inflation data continue to test the Bank’s resolve. The Bank also used new language to characterise the overall position of the economy, writing that it is “clearly operating in excess demand,” versus the “moving into excess demand” comment from the April rate statement.
While the development in the Bank of Canada’s language towards inflation and the path of monetary policy was fairly seismic in the grand scheme of things, the reaction in the Canadian dollar was fairly muted as the 14.1bp rise in 2-year Canadian bond yields was negated by rising front-end Treasury yields after strong ISM data for May.
Terminal rate pricing of the BoC is likely to return above 3.5% as the BoC strikes a more aggressive tone in today’s rate statement.
Simon Harvey, Head of FX Analysis
Jay Zhao-Murray, FX Market Analyst