BoC Preview: Forecasts from seven major banks, no incentive to drop threat of hikes

Canadian core inflation came in hotter than expected in December and rules out the BoC shifting meaningfully in a dovish direction at the January policy meeting. However, higher interest rates are biting. The latest BoC Business Outlook Survey reported softening demand and ‘less favourable business conditions’ in the fourth quarter with high interest rates having ‘negatively impacted a majority of firms’, leading to most firms not planning to add new staff. As such, inflation looks set to soften further in coming months and so we favour rate cuts from the second quarter onwards, most likely starting in April.

We look for the BoC to stick to the script as it holds the overnight rate at 5.00% and maintains its current guidance. Renewed momentum across core inflation and wage growth has reduced the scope for any pivot in the Bank's messaging, and we look for the statement to lean hawkish with an emphasis on the persistence of price pressures despite mild downward revisions to MPR forecasts. This can support the CAD, especially vs G10 peers where central banks are more dovish like the CHF.

The BoC is widely expected to hold the overnight rate steady at 5% in the first policy decision of 2024 – extending a pause that started following the last hike in July. We expect the BoC to push back against the idea that a shift to interest rate cuts is coming soon. There is some potential that the central bank could hint at an earlier-than-expected end to quantitative tightening policy but would likely take pains to communicate the primary objective of that change would be to ensure adequate liquidity in funding markets rather than flagging a shift to easier monetary policy and imminent rate cuts. The BoC will be cautious about declaring victory over inflation too soon. We expect the first decrease in the overnight rate to come around the middle of this year, and that to be followed by 75 bps more later in the year to lower the overnight rate to 4% by the end of 2024.

The BoC is widely expected to leave its policy rate unchanged at 5% for the fourth consecutive meeting. More intriguing than the headline decision on rates will be guidance offered by Governing Council. With the Bank’s preferred measures of core inflation accelerating in recent months, we don’t expect policymakers to materially water down their hiking bias. It’s more likely than not that the statement reiterates ‘Governing Council remains prepared to raise the policy rate further, if needed’.

Not much has changed over the past few months. Growth in Canada remains weak and inflation, as judged by the Bank’s preferred core measures, has shown some but not enough progress. We expect that to be the main message of the press conference will be to draw a line in the sand that we need to see further progress on the inflation before discussing rate cuts. There will likely be another token reference to the possibility of further monetary restraint, but that should be balanced by an acknowledgement of flexibility to get back to target and the outsized role of shelter costs. What we would like to see is the Bank putting greater weight on a broader set of inflation measures (cough …*CPIX*…cough) as a guidepost to monetary policy.

No change is expected in the overnight rate for the fourth consecutive meeting. There have also been some rumblings about potential changes to quantitative tightening (QT), but we aren’t expecting any shifts on that front just yet either (though there’s an outside chance of a tweak). There’s no denying there’s been progress on bringing inflation lower; however, it’s also clear that there’s still plenty of work to do to get back to 2%. Rate cuts are very likely in 2024, but the Bank of Canada is going to remain as patient as possible for inflation and inflation expectations to retreat further. Following three years of well-above-target inflation, the last thing policymakers want to do is ease policy too early and allow inflation to re-accelerate.

We expect the BoC to hold its policy rate at 5.00%. However, the accompanying statement may lean hawkish in tone. We expect the BoC to repeat that it is still concerned about risks to the inflation outlook and remains prepared to raise the policy rate further if needed. Wage growth and services inflation will likely remain areas of focus for BoC policymakers. The BoC will also offer updated economic projections at this meeting. Forecasts for a more gradual return of CPI inflation toward the 2% target (currently seen happening by the end of 2025) would also likely be viewed as a hawkish signal.