Canada | Rates are headed up, but slower than markets expect

The Bank of Canada removed its forward guidance in January and clearly signalled an imminent tightening of monetary policy. Assuming a swift end to the Omicron wave, we expect the Bank will begin to raise rates in March, hiking a total of four times before year-end. By mid-2022, the Bank is also likely to start shrinking its balance sheet by allowing maturing bonds to roll off.

What you will learn:

• Our forecast is below market expectations and calls for the policy rate to reach 1.25% by year end. We anticipate the Bank will then pause to assess how the economy is faring before gradually lifting the policy rate to its neutral level of 2% by mid-2024.
• We believe the Bank will proceed cautiously in raising rates to avoid aggravating key vulnerabilities around elevated household debt and overvalued house prices. Also, the Bank’s new explicit focus on “maximum sustainable employment”, may prompt it to test the NAIRU, possibly allowing a lower unemployment rate without higher inflation.
• We forecast inflation will remain elevated in early 2022, peaking around 5% this spring before slowing to the low-2% range by mid-2023 as supply bottlenecks gradually clear and energy prices fall from current heights. Still, high inflation may prove stickier if a protracted pandemic results in further restrictions across the globe that cramp s