Bank of Canada Expected To Begin Doubling Rate Hikes Next Month, Reverse QE

Canada’s central bank is forecast to increase their fight against inflation. BMO Capital Markets released its latest forecast showing more aggressive rate hikes. They now see the Bank of Canada (BoC) hiking at double the previous forecast for at least two meetings. The accelerated hikes are just a part of the central bank’s battle to try and control inflation.

The BoC Expected To Use Double-Sized Rate Hikes To Curb Inflation

BMO is hiking its interest rate forecast following market expectations and BoC language. The central bank’s deputy governor recently said they would evaluate the “pace and magnitude” of rate hikes. That’s a sign they’ll adopt an approach that better reflects market expectations.

The BMO forecast shows two 50 basis point (bp) hikes by the June meeting. The double-paced rate hikes are then expected to be followed by a 25 bp hike in July. That would put the BoC overnight rate at the pre-2020 level within weeks. 

Interest Rates Are Expected to Hit A Neutral Policy Rate Very Fast

The BoC estimates 1.75% is the low range of the neutral policy rate, which will be hit within months. A neutral policy rate is the point where monetary policy provides no influence. Below the neutral is expansionary, meaning stimulus for economic growth. Above the neutral rate is when monetary policy slows growth. The BoC estimates the neutral range to be between 1.75% and 2.75%, with more forecasts now predicting the higher end of the range will be needed.

“We then expect a more tepid pace of tightening with 25 bp rate hikes at each of the next three MPR meetings, leaving policy rates at 2.5%, toward the higher end of the BoC’s neutral range, consistent with still-stubborn, if easing, inflation pressures,” said Michael Gregory, BMO’s Deputy Chief Economist.

In this scenario, the BoC’s overnight rate hits 2.5% in the first quarter of 2023. The rate would be the highest since 2008, a level most thought would never be touched again. It seems less extreme when you realize they’re doing it to tackle the highest inflation since the 90s. The current inflation environment is something Canada hasn’t seen in a very long time.

Quantitative Tightening To Roll Back QE Soon

Quantitative tightening (QT) is expected to be rolled out soon to help curb excess demand. Quantitative ease (QE) is a program where the central bank injects liquidity into the market. This is designed to increase demand for goods and services, thus creating inflation. QT is the exact opposite, used to reverse QE. This would further help fight inflation beyond the impact of interest rates. If QE boosted sales, QT should reverse that volume boost.

QT has been confirmed by the BoC, they just haven’t explained when it’s coming. BMO thinks the April meeting in a couple weeks will be the start of the QT party. This could help normalize demand much faster than interest rates by themselves. They could have used much less tightening had they started a year ago, when they were expected to act. Waiting longer would introduce more issues, so tackling it ASAP is a smart idea.

BMO’s forecast expects the BoC to act quickly to hit the neutral policy rate. Our neighbors to the South at the US Federal Reserve said they might need to go even further than the policy rate. If that’s the case in Canada, buckle up — inflation problems are worse than expected.