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The Bank of Canada raises interest rates

Bank of Canada building.

Key takeaways

  • The Bank of Canada increased its target for the overnight rate to 0.50%.
  • Further increases and quantitative tightening are coming.
  • Economic growth is solid, and inflation remains elevated.

And so, it begins. As widely expected, the Bank of Canada (BoC) announced that it would increase its target for the overnight rate to 0.50% this week. Additionally, the BoC will continue with the reinvestment phase of its quantitative easing program – only buying bonds to replace maturing assets – at this time.

As the economy continues to recover and grow and inflation remains elevated, the Bank confirmed expectations by noting that it expects interest rates will need to rise further. Also explicitly noted, the BoC is considering when to end the reinvestment phase and when to start decreasing its holdings of Government of Canada bonds to tighten conditions.

The Russia-Ukraine conflict is a major new source of uncertainty

The invasion of Ukraine has driven prices for oil and other commodities higher. This will, without a doubt, place upward pressure on inflation globally. Unsurprisingly, volatility has increased throughout global financial markets. The Bank expects that the conflict will likely have a negative impact on confidence and introduce new supply chain disruptions that could support elevated inflation further, while weighing on global growth.

Economic growth is solid

According to the BoC, global economies are shrugging off the Omicron variant more quickly than expected. It did mention that the latest variant “continues to circulate and the possibility of new variants remains a concern.” The Bank reported that demand is robust, especially in the U.S., and that supply chain bottlenecks have eased in some areas but remains challenging. Overall, global economic growth is in line with projections made in the Bank’s January Monetary Policy Report (MPR).

In Canada, growth in the fourth quarter of 2021 came in stronger than the Bank’s estimate, at 6.7%. The BoC commented that economic growth “was very strong” and that this “confirms its view that economic slack has been absorbed.” Imports and exports have expanded, household spending is strong (and should strengthen further with easing health restrictions) and the housing market remains elevated.

Inflation remains stubbornly high

Price increases have spread, and CPI inflation has risen to 5.1% – well above the BoC’s 2% long-run target. As mentioned earlier, the Russia-Ukraine conflict will push prices for energy and good-related commodities higher. We’ve seen poor harvest yields and increased transport costs that could also push up prices for foodstuffs.

The Bank noted that it expects inflation to be higher in the near-term than what was projected in the January MPR. It is aware that stubbornly high near-term inflation increases the risk of higher longer-term inflation expectations and, is in part, the rationale for this week’s rate increase. The pace of further interest rate increases, and the initiation of quantitative tightening will be guided by the Bank’s continuous assessment of the economy and its commitment to maximum employment and its inflation target.

This announcement is in-line with our expectations

Equity markets traded higher on Wednesday as did bond yields, but this is more likely a gyration from the ongoing Russia-Ukraine conflict, a recovery for Tuesday’s declines. The Canadian dollar appreciated against the U.S. dollar throughout the day.

Currently, we remain overweight equities relative to fixed income and cash as we continue to see a low probability of recession over the next 12 months. Within our equity exposure, we continue to favour developed, North American equities, particularly U.S. equities, as growth and earnings will likely remain above potential.

We have a reduced our exposure to interest rate risk with a short-duration bias within our domestic fixed income universe funds. Near-term volatility will be elevated for Canadian bond yields and we believe that yields already account for the additional rate increases referenced in the Bank’s announcement.

For more information about this announcement or our positioning, please contact your MD Advisor*.

The BoC’s next interest rate announcement is scheduled for April 13.

 

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec).

The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.

About the Author

Wesley Blight, CFA, CIM, FCSI, is an Assistant Vice President with the Multi-Asset Management team. He is responsible for the investment results of the firm’s fixed income and multi-asset products.

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