Last Wednesday, the Bank of Canada (BoC) raised its benchmark interest rate for the first time since 2010. The rate went from .50 percent to .75 percent.
The move was widely anticipated, but the accompanying statement and press conference significantly changed market perceptions about where the BoC - and the Canadian economy as a whole – are going from here.
The magnitude of this sea change in Canada is hard to overstate. A month ago, market expectations for this BoC meeting put the odds of a rate hike at about 5 percent. They were up to 90 percent by the end of the first week of July, as Bank of Canada officials laid the groundwork for the rate hike.
But when the decision was announced, we saw a nearly 2 percent move toward Canadian dollar strength in the space of two hours, before some consolidation, and two-year interest rates rose by 7 basis points.
The BoC added to market enthusiasm by opining that the “output gap” – that distance between where the economy should operate and where it actually is operating – will close late this year, which is months earlier than originally anticipated. The central bank also dropped wording about any concern that the strong currency would hurt exports – giving traders the green light to push the Canadian dollar higher.
In a sense, the Bank of Canada's policy path is a mirror image of the discussion we had two weeks ago regarding the European Central Bank and Bank of England.
- Leaders of both those institutions had their verbal cues misinterpreted by markets, which mistakenly interpreted them as initiating the possibility of tightening rates.
- But both remain accommodative.
- The BoC, on the other hand, has quickly turned hawkish and set itself on a path to higher rates.
The next question is, “Where do we go from here?”
Our parent company – The Royal Bank of Canada (RBC) – believes the BoC will raise rates again in October, with a pause to gauge the economy's reaction to the higher rates and to see if the BoC is confident it will hit its 2 percent inflation target.
On the currency side, RBC shifted its stance on the Canadian dollar in the wake of this hawkish BoC sentiment. Going into the meeting, RBC analysts were looking for some moderate strengthening to the end of the third quarter.
At the moment, it looks like “moderate” strength is an understatement.
My View: Clearly Canada is back in play in the ongoing global central bank rate forecast “parlor game.” Expect to hear more about the economy of our neighbor to the north and how it will affect markets throughout the rest of this year.
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