Bank of Canada Preview: Strong Data to Prompt a 25bp Hike

Summary

• The labour force has continued to prove resilient with participation climbing, unemployment lower and wage growth remaining positive (vs core).
• Core disinflation progress has stagnated.
• Recent Business and Consumer Outlook Surveys are supportive of persistent inflation with expectations for inflation increasing in both level and duration.
• As a result, we expect the Bank of Canada (BoC) will hike by 25bp to 4.5%.

Market Implications

• AUD/CAD may retrace some of its recent run.

One Last Hike

At their December meeting, the BoC hiked the policy rate by 50bp to 4.25%, larger than our expectation for a 25bp move. However, the change of language was most important. Notably, they listed necessary conditions for them to pause. We expect a slowdown to a 25bp hike at tomorrow’s meeting for the following reasons.

Labour Force Proving Resilient

The labour force is proving resilient.Through December,participation climbed 0.2pp (to 65.0% from 64.8%) while unemployment (5.0%) slipped closer to 50-year lows as employment rose +104,000 – the majority was in full-time work (+84.5k). Meanwhile, wage growth remained above +5.0% YoY for the seventh consecutive month with 75% of 2022 seeing stronger wage growth than historically seen.

Looking forward, our model for Canadian employment suggests further upside for the employment rate (note: the spike is induced by one strong data point; Chart 1). We still see a strong jump in employment ahead when taking a relatively conservative outlook.

Core Inflation Failed to Retreat Further

Inflation remains the core target of BoC monetary policy. On this front, three-month annualised core inflation is failing to retreat. It was outlined as a concern in December, noting a desire for the trend lower to sustainably continue. However, this failed to materialise. At best, they have moved sideways. In reality, both median and trim three-month annualised growth measures are higher than they were during the December meeting (Chart 2).

BoC Survey Supportive of Final Hike

The Business and Consumer Outlook Surveys delivered the final piece of information we needed. It showed a larger share of participants expecting inflation above 3% (to 84% from 77%) and that it would take longer than previously expected for it to return to target, with the plurality of participants now expecting normalisation not to occur until 2026 or later (previously 2024, Chart 3).

However, warning signs are showing. Sales growth has dwindled and is expected to worsen going forward, CAPEX is below year norms (1/5 say tight financial conditions are holding their investments back), and overall indicators of future sales have retreated. It comes as consumers are finding it more difficult to obtain credit ahead of an expected recession (Chart 4). This may very well be the last hike from the BoC, in line with markets pricing a c.4.5% terminal rate.

Market Implications

Markets are pricing just 20bp for the meeting, not 25bp as we expect and have yet to price in enough cuts.

Looking at FX, we remain bearish CAD with other commodity currencies better exposed to the China re-opening trade and less exposed to a slowdown in US growth. However, the 8% run higher in AUD/CAD could see tactical retracement as the China reopening story fades or if US data surprises.

Ben Ford is a Researcher at Macro Hive. Ben studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)