While the Bank of Canada left its benchmark rate unchanged as expected today, markets instead turned their attention to the release of another hot inflation report out of the U.S.
U.S. CPI inflation was 0.4% in March, a repeat of the strong reading seen in February and part of an uptrend in headline inflation this year. On an annualized basis, inflation rose by a higher-than-expected 3.5%, leading to a surge in bond yields and a selloff in equity markets.
This is important due to the implications for both the Federal Reserve and in turn the Bank of Canada’s future monetary policy decisions.
“The March CPI inflation report is an unwelcome message to the markets that the Fed’s inflation fight is far from over,” noted BMO’s Scott Anderson.
As a result, rate cuts could very well get pushed out to later this year, or potentially even until next year, says Scotiabank’s Derek Holt.
“Forget rate cuts in 2024? That’s a very distinct possibility,” he wrote, pointing to the nearly instant response by markets that all but eliminated their pricing for a June rate cut by the Fed.
“Markets are now pricing about a half percentage point cumulative rate cut by year-end at most,” he added. “As for the BoC, they’re…less likely to turn dovish now given the risk of totally un-mooring CAD with the Fed being pushed down and out.”
A different inflation story in Canada
In its statement today, the Bank of Canada did sound a hint dovish, pointing to progress made on reining in inflation and noting that the easing is becoming more broad-based across both goods and services.
“While inflation is still too high and risks remain, CPI and core inflation have eased further in recent months,” the Bank said. “The Council will be looking for evidence that this downward momentum is sustained.”
In February, headline inflation eased to 2.8%, while both of the Bank of Canada’s preferred measures of core inflation also slowed more than expected.
In its newly released forecast included in today’s Monetary Policy Report, the BoC said it now expects headline inflation to remain near 3% for the first half of this year before moving below 2.50% in the second half.
“The Bank of Canada was mildly more dovish noting the encouraging core inflation trend and softening labour market,” wrote BMO’s Benjamin Reitzes. “However, policymakers need more evidence that this trend will continue before they’re willing to start easing.”
James Orlando, senior economist at TD Economics, said that even though inflation is now within the Bank’s neutral target range of between 1% and 3%, “markets have become more cautious on the timing of cuts.”
Part of that is due to today’s strong U.S. inflation report, as mentioned above, but also due to stronger-than-anticipated GDP growth here in Canada.
On that front, the Bank of Canada also upwardly revised its GDP growth forecasts to an average of 1.5% in 2024 from its previous estimate of 0.8%.
Today’s rate decision also saw the Bank of Canada increase its estimated nominal neutral rate by 25 basis points to a new range of 2.25% to 3.25%. The neutral rate is defined as the real interest rate that balances the economy at full employment and maximum output.
“This increase reflects the impacts of an upward revision to the U.S. neutral rate and changes in key Canadian domestic factors,” the BoC said.
Latest Bank of Canada economic forecasts
In its latest MPR, the Bank unveiled some updates to its economic projections.
GDP forecast
The Bank now expects annual economic growth of:
- 1.5% in 2024 (vs. 0.8% in its January forecast)
- 2.2% in 2025 (vs. 2.4%)
- 1.9% in 2026
Inflation
Meanwhile, the Bank’s inflation forecasts were revised downward for this year.
- 2.6% in 2024 (vs. 2.8%)
- 2.2% in 2025 (unchanged)
- 2.1% in 2026
The Bank of Canada’s next rate decision is scheduled for June 5, 2024.
