The Bank of Canada (BoC) raised the overnight rate to 1% and stated that it will start Quantitative Tightening (QT). This means that it will allow maturing government bond holdings to run off its balance sheet.
On the economic outlook, the Bank noted that “growth is strong and the economy is moving into excess demand. Labour markets are tight, and wage growth is back to its pre-pandemic pace and rising.”
Its growth forecast remains solid, as the Bank believes “Canada’s economy will grow by 4¼% this year before slowing to 3¼% in 2023 and 2¼% in 2024. Robust business investment, labour productivity growth and higher immigration will add to the economy’s productive capacity, while higher interest rates should moderate growth in domestic demand.”
On inflation, it stated that “CPI inflation is now expected to average almost 6% in the first half of 2022 and remain well above the control range throughout this year.”
Key Implications
Bam! The BoC stepped up with a widely expected acceleration in its tightening cycle. With inflation pushing towards 6%, the labour market at full employment, and output pushing on capacity constraints, the Bank needed aggressive action. By raising the policy rate by 50 basis points for the first time in 22 years, the BoC is setting the pace for more aggressive moves in the coming months.
Our expectation is for the BoC to execute on another 50 basis point hike on June 1st and get the policy rate to 2% by year end. With the Bank’s initiation of QT alongside higher policy rates, government bond yields should remain at current elevated levels.
