Bank of Canada Hawkishly Surprises Markets

• BoC hiked 50bps, more than priced, matching our soft conviction

• Forward guidance struck the right balance toward next steps…

• ...by leaving the door a little less open to another rate hike

• The next move depends highly upon data and event risk over the next seven weeks

• What changed in the statement and what’s next for communications.

The BoC hiked by 50bps and left the door a little less open to continuing to raise its policy rate. On balance the statement was more hawkish than markets anticipated. It was in line with Scotia’s expectations for 50bps and forward guidance, albeit we had warned that conviction was pretty soft around multiple scenarios.

Markets responded by raising the 2-year Government of Canada bond yield by 10 bps, lifting the 5 year yield by 8 bps, and raising terminal rate pricing by about 9bps and are pricing part of another 25bps hike into January and subsequently before starting to price the chance at a rate cut by the end of next year. The Canadian dollar also appreciated by a half penny at first but has since drawn even post-statement partly due to safe haven seeking into the USD on Putin’s repeated warnings about nukes that hit headlines shortly after the BoC statement arrived. Chart 1 shows the meeting-by-meeting market pricing of future moves pre-statement, post-statement but pre-Putin and post-statement and post-Putin. 

What they Said

Key in the attached statement comparison is the final paragraph. They are now “considering” whether to continue hiking versus the prior determination.

That’s actually not as big of a change as some are making it out to be. Here’s what they said in October:

“The Governing Council expects that the policy interest rate will need to rise further. Future rate increases will be influenced by our assessments of how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding. “

And here is what they now say:

“Looking ahead, Governing Council will be considering whether the policy interest rate needs to rise further to bring supply and demand back into balance and return inflation to target. Governing Council continues to assess how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding.”

And so you could argue that they took the first step to sounding more cautious with their forward guidance at the October meeting and built upon that today. Instead of “will need to rise further” alongside conditional language around future hikes after this one, they are now “considering” whether to hike again after today’s 50bps which sounds a little less decisive.

It’s not, in my opinion, a quantum shift. That language closes the door to further hikes a touch more than what they had already intimated in the October statement but nevertheless leaves it open.

Other notable changes in the statement included the following points with assessments of each points hawkish/dovish slant:

• They acknowledged that global growth “is proving more resilient than was expected” in the October MPR. That’s hawkish in isolation.
• They signalled unease toward the risks facing supply chains by noting that “further progress could be disrupted by geopolitical events.” I swear Putin read that when he warned about nukes 10 minutes after the statement dropped. This is also mildly more hawkish from the standpoint of potentially interrupting disinflationary progress.
• The BoC flagged that Q3 Canadian growth was stronger than they forecast. About double to be exact. That’s also hawkish acknowledgement that the economy pushed further into excess demand conditions, but it’s just a statement of already known fact.
• Netting through the growth drivers, they reaffirmed “the Bank’s outlook that growth will essentially stall through the end of this year and the first half of next year.” That’s the not-recession-because-we-can’t-say-it nod. Dovish, but not incrementally so.
• The main dovish nod was the reference to how “Three-month rates of change in core inflation have come down, an early indicator that price pressures may be losing momentum.” That’s a little stronger than the prior statement’s comment on the 3-month trend. The caution here is whether that’s just a transitory development in the context of still strong underlying cyclical and structural drivers.
• Nevertheless, they took that back in part by noting that “inflation is still too high and short-term inflation expectations remain elevated” while repeating worry about expectations the longer inflation remains above target.

PRESERVING OPTIONALITY

Overall I think they did the right thing here given what we know to this point. Slamming the door shut by declaring an absolute end to the hike cycle would have been too aggressive in my view and as the policy rate pushes further into restrictive territory they should be transitioning toward something that is more sensitive to new information. My conviction toward the BoC’s stance was high from when I was writing notes in late 2020 and early 2021 saying they’d hike by early 2022 while they underestimated inflation risk, but that conviction is much weaker the further we push into restrictive territory for the policy rate.

On that note, the forward guidance sounds more conditional which increases optionality into the January 25^th meeting which in today’s world may as well be a decade from now. By then we will have two more CPI prints to inform whether they’ve been head faked of late or something more durable is building, plus another jobs report alongside greater clarity around how high the Fed is willing to go.

HAWKISH OR DOVISH?

So do you call it dovish, hawkish, or somewhere in between? Hiking more than was priced and leaving the door open without a clearer signal that "we're done!" is pretty clearly more hawkish than markets expected. The market reaction is likely sensible to this point. Now we have a job to do in tracking developments on the rather long road until the next full forecast meeting.

LEFT UNANSWERED

Not once was there a reference to wage growth and wage-price pressures. Wage growth is strong in Canada and productivity has tumbled throughout the pandemic. Governor Macklem has delivered a speech that boldly declared wage growth was peaking now which is highly debatable and he also failed to even mention moribund labour productivity. Is the reason such references are absent from the statement a sign he is wavering after the last jobs report? Why not statement-codify such an expectation if he still so strongly believes this?

Also, what does the Governor now think of CAD? He sparked interest with his comments earlier this Fall that suggested greater unease toward the Canadian dollar’s depreciation. Then he went quiet on the topic as CAD appreciated from mid-October to early November. Now that it has resumed trend weakening notwithstanding today’s modest move is he more or less concerned about CAD and layering on lagging price pass through effects into next year? Normally the BoC would look through this, but we don’t have normal inflation or normal expectations and so what the Governor thinks about another modest potential upside catalyst to inflation may be useful to know.

NEXT UP

Deputy Governor Kozicki delivers the customary day after BoC speech tomorrow. The embargo lifts at 12:30pmET and there will be a press conference at 2pmET.

Governor Macklem then speaks next week on Monday to deliver the Governor's usual pre-holiday speech and press conference (here). Last year's was a hawkish pivot (and then he whiffed in January, but anyway...).  I think his speech is likely to follow a similar tone to the statement but he may add to our understanding of the probability of approaching an end to the rate hike cycle.