HOT INFLATION CAUTIONS AGAINST DOVISH TURN
Core inflation in Canada exceeded expectations in December, making a significant shift towards a dovish stance by the Bank of Canada (BoC) in January unlikely. Despite this, the article suggests that higher interest rates are causing concern, leading to expectations of rate cuts starting in the second quarter. It is anticipated that the Canadian dollar’s value and US-dependent BoC rate expectations will remain relatively stable in the near term.
BOC EXPECTED TO MAINTAIN INTEREST RATE, BUT INFLATION CONTINUES TO RISE
The BoC is expected to keep its target overnight rate at 5% during its upcoming meeting. Policymakers have expressed a willingness to raise rates further if necessary, given the persistently high inflation levels. However, the article predicts that the BoC is more likely to cut interest rates, possibly at the April meeting, rather than tightening policy further.
CHALLENGING ECONOMIC CONDITIONS
The latest BoC Business Outlook Survey reports weakening demand and less favorable business conditions in the fourth quarter. High interest rates have negatively affected many firms, leading most of them to refrain from hiring new staff. Job growth is slowing, and the Canadian economy contracted in the third quarter, with expectations of sub-1% growth in the fourth quarter. Rising Canadian mortgage rates will add financial pressure to households, dampening consumer spending and inflationary pressures. Unemployment is also expected to rise due to reduced job creation and high immigration rates.
EXPECTED DECLINE IN CANADIAN INFLATION AND RATE CUTS
The article predicts that Canadian headline inflation will decrease to 2.7% in the first quarter and reach 2% in the second quarter, compared to a consensus forecast of 2.6%. Consequently, there is scope for the BoC to implement 25 basis point (bp) interest rate cuts at every meeting starting in April, totaling 150bp of rate cuts compared to the consensus prediction of 100bp.
RATE EXPECTATIONS AND FOREX IMPACT
Market expectations currently suggest a 95/100bp easing of interest rates by the BoC in the current year. Despite some differences in communication between the BoC and the Federal Reserve, the timing and expectations for the first rate cut are comparable, with the BoC expected to cut rates in June. The Canadian dollar’s performance is seen as closely linked to US-related sentiment rather than traditional commodity currency factors. While the article anticipates a modestly positive impact on the Canadian dollar due to scaled-back dovish expectations, it also notes that the USD/CAD exchange rate may stabilize, with limited downside in the near term.
KEY TAKEAWAYS:
- Core inflation in Canada exceeded expectations in December, making a dovish shift by the BoC in January unlikely.
- The BoC is expected to maintain the target overnight rate at 5% but may cut rates in the second quarter due to concerns about higher interest rates.
- Challenging economic conditions in Canada include softening demand, unfavorable business conditions, and slow job growth.
- Predictions suggest a decline in Canadian inflation and the possibility of 150bp of rate cuts by the BoC from April onwards.
- The Canadian dollar’s performance is influenced by US-related sentiment, and the USD/CAD exchange rate may stabilize in the near term.