BoC: Ready or not, a rate hike is coming – BMO CM

Benjamin Reitzes, Canadian Rates &  Macro Strategist at BMO capital Markets, expects the Bank of Canada to hike its policy rate for the first time in seven years, up 25 bps today, bringing the overnight rate to 0.75%.

Key Quotes

‘While the merits of a move can be debated, a string of speeches and interviews from BoC officials has made it clear that a rate hike is coming. A consensus appears to have formed around a July hike as there can be little other reason for the timing of the rhetoric shift. If they wanted to wait until October to hike, why not signal such a move at the coming meeting instead of a month earlier?’

“The Bank has laid out two main rationales for the anticipated hike:

1) In 2015, the BoC cut rates 50 bps to facilitate the economic adjustment to the precipitous drop in oil prices. Following 3.5% average GDP growth from 2016Q3 to 2017Q1, policymakers reasonably believe that the adjustment is “largely” complete. Indeed, we’ve seen activity pick up strongly in oil-producing regions corroborating the narrative. Accordingly, it follows that removing 2015’s 50 bps of easing makes sense.

2) The April MPR projected the output gap would close in 2018H1, and the data since then should keep that timeline intact. In the three tightening cycles since 2000, the Bank has started hiking around one year ahead of when the output gap is forecast to close. July fits nicely in that window, while October risks falling a bit behind the curve if the output gap closes in the early part of H1. Both Governor Poloz and Sr. Dep. Governor Wilkins said that monetary policy has to act preemptively due to the lagged effect of a move. This line of thinking is more consistent with a July move being the start of a more traditional tightening cycle.”

“That call for pre-emptive action is a key rebuttal to the naysayers, who have largely pinned their argument on the deceleration in core CPI. There’s no denying that core CPI has slowed, but if the Bank believes it will accelerate over the next year, there’s little merit to the argument against a move. Beyond CPI, it’s tough to say the economy needs this level of stimulus, with nearly every other indicator on fire. Even exports are showing some signs of life with non-energy export volumes rising in three straight months.”

“The Monetary Policy Report will likely see some moderate forecast changes, mainly on the inflation front. Headline CPI (all the Bank forecasts now) has slowed much more than expected, with energy prices playing a key role. Even so, look for a return to about 2% by mid-2018. On the growth front, the Bank did a solid job in April. The 2017 forecast could climb a tick or two, while Q2 isn’t likely to move much (maybe a snick higher). A Q3 GDP forecast will be introduced and will likely come in the low 2% area, above potential but slowing. The overall forecast is expected to be consistent with steady, if slow, policy tightening.”

“Key Takeaway: The BoC has had ample opportunity to walk the market back from July rate hike expectations, and instead chose to reinforce them. The bigger question markets will be watching for is the timing of the next move (October or January), and how aggressive the BoC will tighten through this cycle.”