The Bank of Canada kept its policy rate at 0.25% at its January meeting on Wednesday as it prepares to hike rates in March and subsequently draw down its balance sheet.
The central bank has removed its exceptional forward guidance on its policy rate, saying that “the economic slack is now absorbed.”
In its announcement, the central bank has removed its exceptional forward guidance on its policy rate, saying that “the economic slack is now absorbed.”
While the market has priced in six rate hikes over the next 12 months, which seems overzealous, four rate hikes are not out of the question.
Amid a strong recovery with robust demand, labor shortages and inflation at a 30-year high, a rate hike in March is likely as the bank seeks to tame inflation.
A strong labor market was a key factor for the central bank’s decision. Job reports for November and December showed exceptionally strong gains. Demand for labor is at the highest level in two decades, and the economy is on track to achieve maximum sustainable employment.
While wage gains still trail inflation for now, they are picking up rapidly across industries.
In addition to rate hikes, a policy tightening also involves the drawing down of the Bank of Canada’s balance sheet by allowing a roll-off of maturing Canadian government bonds. The balance sheet has ballooned to quadruple its pre-pandemic size, an enormous increase compared to other central banks even by pandemic standards.
Money market rates are moving away from the zero bound, and 10-year yields are moving higher in both the United States and Canada as markets anticipate further rate hikes and quantitative tightening.
While activities are slowing in the first quarter as the omicron variant has led to tightened restrictions, the economic impact of omicron and future variants are likely to be less severe than during the pre-vaccine era. Canada’s gross domestic product this year is expected to grow by 4%, just shy of last year’s growth of 4.5%.
Increased economic activity and geopolitical concerns will increase the demand for energy at a time of limited supply, and as a result, the Canadian dollar will remain strong.
The takeaway
In a world plagued by the pandemic uncertainties, an orderly and gradual approach to address persistent inflation and supply chain struggles is proving to be favorable.
