by Avi Hooper, Invesco Canada
As widely anticipated by the market and bank economists, the Bank of Canada increased the overnight policy rate to 1% from 0.50%. Importantly, the neutral rate is now believed to around 2.5%, higher than the previous economic cycle peak owing to more pervasive inflationary pressures.
The Bank will exit the reinvestment phase and start quantitative tightening next week. This will not include active selling of current holdings, rather a complete absence from previous government bond buying in the primary and secondary markets. Given the improved fiscal outlook and less forthcoming bond issuance, we don’t expect this to have a meaningful market impact.
Growth expectations were increased this year, but the economy is set to decelerate in 2023. The inflation forecast was materially increased for 2022, which was the main driver for the hawkish policy decision. Supply price pressures, exacerbated by the invasion of Ukraine, have become a greater concern as the risk of inflation expectations becoming unanchored grows.
Increasing the expected neutral rate to 2%-3% was the clearest statement from the Bank that monetary policy may need to become restrictive. Our long-held view has been that the neutral rate was around 2%. A move to restrictive territory would be felt in the real economy far sooner than in the past. Variable rate mortgages are now 30% of the total.1 If non-mortgage debt was included, approximately 40% of outstanding personal debt is immediately exposed to rate hikes. 1
The Bank of Canada appears to have finally met market expectations. A restrictive policy will clearly slow growth and moderate the current pace of inflation. Amidst a backdrop of uncertain monetary policy, valuations in fixed income have become attractive, in our view. Downside risks to economic growth could see fixed income inflows return.
1 Source: BMO Capital Markets, April 11, 2022
This post was first published at the official blog of Invesco Canada.
