Bank of Canada’s war on inflation generates uncertainty among investors

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Markets have rallied in recent months on conflicting signals about when monetary policy might re-align with investor interests.Sean Kilpatrick / The Canadian Press

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Nearly a year after the Bank of Canada declared war on inflation, investors have no idea what’s coming next.


On Wednesday, the central bank is set to announce its next decision on interest rates, and another hike looks likely. This would mark eight consecutive increases since March, taking the country’s policy rate to its highest level in at least 15 years.

But there is little agreement on how the Bank of Canada would like to proceed.

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Financial markets are placing the odds of a 25-basis-point increase at about 70 percent. This is the lowest level of confidence in a hike since the series of rate hikes began, and it is well below the 95 percent chance the market has placed on a United States Federal Reserve rate hike next week. Uncertainty signals a policy pivot in Canada Can’t get away

Investors are just waiting for this.

For years, central bankers were trusted allies of stock market investors. While there is no mandate for the Bank of Canada or the Fed to boost the financial markets, it certainly looks like they were quick to intervene in moments of financial stress.

Beyond the Bank of Canada rate hike: The era of low interest rates is over

Your Personal Inflation Rate: Calculate How You Compare to the Canadian Average

Long after the global financial crisis subsided, interest rates were kept at crisis levels indefinitely. It took more than eight years for the Bank of Canada to raise its policy rate above 1.5 per cent. The Fed followed a similar path, and also began stimulus programs known as quantitative easing.

Those extraordinary measures fueled one of the longest bull markets in US stock market history. Investors began to count on the undying support of central bankers. Eventually, inflation turned that relationship on its head.

In just nine months, the Bank of Canada raised its benchmark rate from 0.25 per cent to 4.25 per cent. The higher rates depend on stock prices in a few different ways. Valuations go down, risk appetite declines and higher borrowing costs affect corporate earnings.

Markets have rallied in recent months on conflicting signals about when monetary policy might re-align with investor interests.

“The central bank is not there to appease the market,” National Bank economists Matthew Arseneau and Taylor Schlecht said in a note. He pointed to the market’s poor recent track record of predicting the Bank of Canada’s moves.

Five of the last eight rate decisions have come either higher or lower than the consensus forecast. Clearly, Bank of Canada is comfortable diverging from investor expectations.

Part of the difficulty in forecasting the bank’s moves is that it relies on economic data, which are a jumble of confusing and contradictory indicators. While there has been a rapid recovery in real estate, for example, the jobs market is still lukewarm, with unemployment at record levels.

All the while, inflation has proved difficult to contain. But December’s readings showed some promise. Annual consumer price index growth for the month fell to 6.3 percent from 6.8 percent in the previous month. In June, it had reached an all-time high of 8.1 per cent.

That’s enough of a restraint for some economists, who are calling on the Bank of Canada to provide relief. “The most aggressive policy rate hike in a generation is taking a toll on the economy,” wrote economists at the National Bank.

Any further increase in the overnight rate “could be the straw that breaks the camel’s back.”

A pair of Bank of Canada surveys released last week suggested both consumer and business sentiment is falling, with a majority of respondents now anticipating a recession this year. Meanwhile, rising mortgage rates are taking a toll on the Canadian housing market.

“The sharp decline in home sales is keeping us awake at night,” Martin Roberts, strategist at Canaccord Genuity Portfolio, said in a note. According to data released last week by the Canadian Real Estate Association, national sales activity for the month of December was down 39.1 per cent from the previous year.

Odds are, though, the Bank of Canada still hikes on Wednesday. “After this hike, we expect the central bank to take a wait-and-see approach,” Mr Roberts said.

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Bank of Canada’s war on inflation generates uncertainty among investors

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