Traders’ bets show they suspect Bank of Canada will raise interest rates early

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Traders are betting the Bank of Canada will be forced to raise interest rates earlier than expected, in one of the toughest tests ever for Governor Tiff McCalem.

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The stakes in the overnight swap market are rising sharply early next year, well ahead of the US Federal Reserve. Traders have now set the price for three hikes in Canada by the end of 2022, which will bring the policy rate down from the current 0.25 percent to one percent.

This is about 50 basis points higher than the market expectation a month ago. The change in pricing is increasingly in line with McCalem’s guidance that borrowing costs will not rise until the slack is absorbed and inflation returns steadily to its target range.

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The bank has repeatedly said that it does not see this happening until the second half of next year.

Analysts warn that uncertainty surrounding liftoff in Canada could undermine the effectiveness of the bank’s forward guidance.

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Derek Holt, an economist at the Bank of Nova Scotia in Toronto, said by email, “If McCalem has increased the starting rate, if McCalem thinks excess capacity may still exist, the entire exhaust structure will turn into a dumpster fire.” Will go.” “This could make forward guidance a very weak tool in the future and increase the risk of policy efficacy.”

Part of the change in stakes, which has also happened for the Fed and the European Central Bank, is proving more frequent than expected due to price pressure.

Statistics Canada is due to report inflation data for September on Wednesday. Economists polled by Bloomberg expect the annual rate to reach 4.3 percent, the highest level in nearly two decades and the sixth consecutive month of readings beyond the central bank’s three percent limit.

On Monday, the Bank of Canada’s quarterly business outlook survey showed that 45 percent of respondents expect inflation to exceed three percent over the next two years. More than 85 per cent people feel that prices are rising faster than the bank’s target of two per cent.

“Taking action a little early in the second half of 2022 seems like the appropriate action,” Jimmy Jean, chief economist at Desjardins Securities Inc., said in a report to investors on Monday. July instead of October. This “could help offset the risk that persistent inflationary pressures lead to a more profound and permanent upward shift in inflation expectations,” he said.

“The market is testing the Bank of Canada’s resolve on forward guidance,” Andrew Calvin, chief Canada strategist for Toronto-Dominion Bank’s securities unit, said by email. His team sees the central bank hiking in July, bringing forward a call from October last week.

“The closer we get to liftoff, we will see increased pressure on the BoC to detach from their forward guidance. Evaluating the strength of the BoC’s commitment can be difficult. “

However, Macklem has somewhat changed the bank’s tune on inflation. Although he considers this to be a temporary phenomenon, the governor said after his October 7 speech that price pressure has stabilized more than the bank initially expected.

He reiterated that point again last week. “It’s probably going to take a little longer for inflation measures to come back,” Macklem told reporters during a video roundtable from Washington after the International Monetary Fund’s annual meetings.

The bank’s next decision is to be taken on October 27. No moves are expected on borrowing costs, but Macklem will reduce weekly purchases of Canadian government bonds to $1 billion from the current pace of $2 billion. All eyes will be on any change in language on rate guidance as well as the inflation outlook in the latest quarterly economic forecasts.

“Either the markets aren’t listening to the bank’s communication around their exit structure, or they don’t believe the argument that we’re still sluggish in the economy, because of price and nascent wage pressures,” Holt said.

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