Further 2023 rate hikes more likely than cuts: BMO's Porter

Interest rate cuts are not on the horizon in 2023 – and the “bigger risk” is that many central banks will continue to raise rates in the near future, according to BMO’s chief economist.

Doug Porter said in a recent publication that bond markets were already attuned to this reality, having driven yields “aggressively higher” to levels not seen since Silicon Valley Bank’s demise just over two months ago.

“Initial optimism on the debt ceiling, hawkish Fed talk, and signs of economic resiliency lit the fire” for a spike in two-year Treasuries in the US, Porter said.

He emphasized the significance of inflation data and its impact on bond markets. “While steady selling in Treasuries set the tone, what really put the cat among the pigeons in Canada’s bond market was the meaty inflation reading for April,” he noted.

The inflation rate defied consensus, ticking up to 4.4% and surprising many market observers. However, Porter said that increase was not entirely unexpected, as his previous warnings highlighted the possibility of a non-linear descent in inflation back to the 2% target.

Examining core inflation indicators in Canada, Porter said, "The Bank’s two preferred measures (trim and median) both eased to 4.2% y/y, while their prior core crush (CPIX) eased to 4.1% y/y, down 2 ppts from last year’s high."

Despite the monthly core moves being stronger than anticipated, the three-month trends on most core measures have remained around 4%. This persistence reinforces Porter's belief that the Bank will need to maintain restrictive rates to counter underlying inflationary pressures.

Acknowledging the rising risks of further rate hikes, Porter said, “Our official call is that the Bank (and the Fed) will keep rates steady at current levels through the remainder of the year. But the risks of further moves are growing, especially after we are on the other side of the debt ceiling drama.”

He pointed to the resilience of the housing sector as a key factor contributing to these risks. Canadian home sales surged by 11% in April, accompanied by price increases and a swing in market balance favouring sellers. This renewed strength in the housing market indicates that monetary conditions may not be sufficiently tight.

Although not booming, the consumer sector is displaying resilience, Porter said, adding to the potential need for higher rates in the future.

While there is the possibility of additional rate hikes, Porter suggested caution and further evaluation of economic indicators before making a definitive decision.

“A better option would be to at least await the May jobs and CPI data,” he said, “not to mention an early look at Q2 GDP, for a more complete picture of how the economy is faring.”