Bank of Canada keeps rates steady but a hike in March is all but certain

• The Bank of Canada held its overnight rate at the effective lower bound of 0.25 per cent. The Bank Rate remained at 0.5 per cent while the deposit rate was also unchanged at 0.25 per cent.
• CPI inflation continues to remain above the target range while core measures have risen since October. The Bank expects CPI inflation to be around 5 per cent in the first half of this year and 3 per cent by the end of the year. In comparison, the Bank expected CPI inflation to be close to 2 per cent in the second half of 2022.
• The Bank has removed its exceptional forward guidance on its policy interest rate. Even though the pandemic continues to impact each Canadian sector differently, the Governing Council has judged that economic slack in the economy is absorbed, satisfying the condition outlined in the Bank’s forward guidance.
• Overall holdings of Government of Canada bonds on the Bank’s balance sheet will remain roughly constant until the policy interest rate is raised. Only then would the Governing Council consider exiting the reinvestment phase and reducing the size of its balance sheet.

Key insights:

• The Bank of Canada’s decision to keep interest rates unchanged came as a surprise to the market. But it didn’t surprise us. It is indeed true that inflation has been above the Bank’s upper target rate of three per cent for nine months. Besides, there is little slack left to absorb in the labour market. Both employment levels, hours worked, and vacancies exceed pre-pandemic levels. What’s more, the level of economic activity in Canada is hovering around full production capacity. Having said that, we knew that Omicron-induced restrictions will undoubtedly slow the economic recovery, making Bank of Canada cautious. An increase in rates when two of Canada’s biggest provinces are under strict restrictions might have sent the wrong signals.
• The Bank still maintains that it will keep its holdings of Government of Canada bonds roughly constant “at least until it begins to raise the policy rate.” With a rate hike in March on the cards, the Bank could exit from its reinvestment phase as soon as March or April.
• The Federal Reserve is also expected to issue a statement today. Currently, the Fed funds futures market has priced in a 94 per cent probability of rates remaining unchanged today. Still, this is not expected to last long as the market believes there is a 92 per cent probability of a first rate hike in March. Bank of Canada will be closely watching Fed’s moves today, with any surprises likely impacting the loonie and importing further inflationary pressures moving forward.