Are markets too optimistic about the possibility of lower rates?
With economic activity and the labour market having proven more robust in 2023 than initially expected, the Bank of Canada will be closely weighing whether further action on interest rates is required – and it appears more inclined towards hikes than cuts at present, according to a leading economist.
Josh Nye (pictured), senior economist at RBC, told Canadian Mortgage Professional that while financial market expectation of a rate cut by the end of the year had surged in recent weeks, central bank governor Tiff Macklem appeared eager to dampen that speculation on Wednesday.
Macklem told a press conference following the Bank’s announcement that it was “prepared to raise the policy rate further” to return inflation to its 2% target if current monetary policy proved too loose.
Nye said the Bank would be watching intently to see whether economic activity begins to tamp down in line with the expectations of its latest Business Outlook Survey, which revealed that businesses forecast slower sales growth in the coming months.
“I think the Bank message… was that they need to continue to see that if they’re going to remain on the sidelines. The market is pricing in about one rate cut by the end of this year,” he said. “That’s a big change from just over a month ago, [when] prior to the turmoil that we saw in the US banking sector the market was pricing in decent odds of another rate hike by the Bank of Canada later this year.
“So that pricing has really shifted from hikes to cuts, and it seems like Macklem was trying to remind folks that [the Bank] has a tightening bias so in their view, the next move is probably more likely to be a hike.”
Even if that hike does not materialize, the Bank is likely to keep rates at an elevated level for an extended period of time, “and probably longer than the market is pricing right now,” according to Nye.
The Bank expects that inflation, which slowed to 5.2% in February, will fall to around the 3% mark by the middle of 2023, before dropping further to its 2% target before the end of next year.
Has anything changed for the housing market?
The Bank of Canada may have adopted a slightly more hawkish tone on possible rate hikes in its latest announcement – but its apparent preference not to cut rates in 2023 was already in line with RBC’s expectations, Nye said, which outline rate decreases to take place next year at the earliest.
That means not much has changed in the housing market outlook after the central bank’s decision, with familiar challenges for many homeowners and homebuyers alike.
“I think Macklem’s message… was that they don’t have any plans to cut interest rates anytime soon,” Nye said. “So if you’re a borrower with a variable-rate mortgage, you might be waiting a bit longer for some relief there. [For] someone who’s trying to get into the housing market, those variable rates aren’t necessarily going to be coming down anytime soon.
“And there wasn’t a ton of market reaction, but we’ve seen five-year Government of Canada bond yields coming down during this period of banking stress. This is maybe a bit of a pushback against that.”
Nesto consulting economist Francis Gosselin told Canadian Mortgage Professional that while there was no prospect of a red-hot market akin to that of 2020 or 2021..https://t.co/zFxZi3Ne8q
— Canadian Mortgage Professional Magazine (@CMPmagazine) April 12, 2023
No change to the Bank’s neutral rate of interest
Despite some suggestions that the Bank of Canada might push its estimate for the neutral interest rate higher in Wednesday’s decision, it opted to stay the course on its 2.5% long-run forecast.
That neutral range is the point at which the central bank deems interest rates neither stimulate nor suffocate economic growth.
Nye said there had been some potential for a reversion back to 2.75% (where it sat before the outbreak of the COVID-19 pandemic), with its decision to leave the estimate untouched a mildly surprising one.
“The implications of that for your average Canadian aren’t necessarily all that significant,” he said, “but when we’re thinking about where monetary policy might end up after the current cycle, they’re saying that neutral is probably closer to 2.5% than the pre-pandemic 2.75% – or even in years prior, [when] it was even higher than that.”
Was the Bank of Canada’s decision to keep interest rates steady the right one? Let us know your thoughts in the comments section below.
