With markets pricing about 18 basis points of tightening, a hike next week is the base case but not fully locked in, leaving room for the Canadian dollar and front-end yields to move on the decision and guidance. Canada’s two-year bonds have been the weakest front end among the major markets, reflecting that shift in pricing. Oil is central to the outlook: Scotiabank flags the risk of an escalation in the Iran war after the US midterms, which could push energy and commodity prices higher and add to Canadian inflation pressure. Higher crude would normally support the Canadian dollar, but it would also strengthen the case for further tightening. If the Bank of Canada holds instead, the loonie would likely weaken, and markets could read the pause as a signal that policymakers are prepared to tolerate inflation near the top of the target range.
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September’s inflation report gave the Bank of Canada a softer headline to point to, but Scotiabank argues that summer travel coming off is no reason to hold rates while the forward-looking risks keep building.
Summary:
- Scotiabank expects the Bank of Canada to raise rates by 25 basis points at its meeting next Wednesday, 28 October.
- Markets were pricing about 18 basis points of tightening after September CPI, unchanged from levels set after Governor Tiff Macklem’s weekend remarks.
- Headline CPI rose to 3.1% y/y in September, a tick below forecasts and at the top of the bank’s 1% to 3% target range.
- Core measures eased in September, but the bank says a sharp drop in travel prices was the main drag and smoothed trends remain warm.
- Scotiabank sees a hike as insurance against upside inflation risks, including possible Iran war escalation, higher commodity prices and fiscal expansion.
- Business and consumer surveys and an Alberta vote are still to come before the decision.
Scotiabank expects the Bank of Canada to raise interest rates by a quarter point at its meeting next Wednesday, arguing that underlying inflation remains warm enough to justify an insurance hike even after a softer-than-expected September price report.
Consumer prices rose 3.1% from a year earlier in September, up from 3.0% in August but a tick below forecasts. That leaves headline inflation at the top end of the central bank’s 1% to 3% target range. Core measures eased in the month, but Scotiabank said upward revisions to earlier data and the smoothed trend still point to persistent pressure, with its preferred three-month averages of the central bank’s core measures running at around 2.6% to 2.7% on an annualised basis.
The bank attributed much of September’s softness to a sharp drop in travel prices as the summer holiday season ended. Travel services prices fell by roughly a quarter on an annualised basis, and car rental prices by close to 40%, a fall far larger than the usual seasonal pattern. Scotiabank said such moves warrant caution over data quality and argued that a slump in travel spending is not a reason to keep rates on hold. Excluding travel, it said core inflation would have been firmer and more broadly based, with almost 60% of the CPI basket rising by 2% or more from a year earlier.
Scotiabank also pointed to a shift in tone from Governor Tiff Macklem, who it says has turned his attention toward forward-looking inflation risks rather than backward-looking data. The central bank dropped its description of the policy rate as appropriate at its previous meeting, which Scotiabank reads as a warning. The bank said policy sits at the lower bound of neutral and is negative in real terms, and that the central bank’s staff have historically tended to underestimate inflation at turning points.
Markets appear to share the view. Pricing for next week held at about 18 basis points of tightening after the CPI release, and Canada’s two-year bonds remain the weakest-performing front end among major markets. Scotiabank said that with a hike largely priced, failing to deliver would loosen financial conditions in a way that would be hard to justify.
Looking further ahead, the bank flagged the risk of an escalation in the Iran war after the US midterm elections, higher energy and commodity prices, and another expansionary federal budget. It argued monetary policy needs to offset some of those pressures as spare capacity closes. Business and consumer surveys from the central bank, along with a vote in Alberta, are still due before the decision.
This article was written by Eamonn Sheridan at investinglive.com.