Why to expect a ‘dovish hike’ from BoC

By Sharon Ho | July 11, 2018 | Last updated on July 11, 2018
5 min read

Strong jobs numbers in June, steady wage growth and rising inflation have led to heightened expectations that the Bank of Canada will raise its target for the overnight rate Wednesday, to 1.5% from 1.25%.

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Canada’s Big Five banks unanimously called for a hike last week, and CIBC Asset Management’s Patrick O’Toole is forecasting “a dovish hike” from the central bank.

In a June 26 interview, he said the BoC has several reasons to raise rates, including inflation exceeding the 2% target. The BoC is aiming to keep inflation at 2%, the “midpoint of an inflation-control target range of 1% to 3%,” said O’Toole, vice-president of global fixed income at CIBC Asset Management.

The inflation rate in May was 2.2% for the second month in a row, Statistics Canada reported. Higher gas prices, restaurant costs, airline tickets and mortgage interest costs were the main contributors to inflation, the agency said.

Canada’s labour market is also doing well, at or near full employment, said O’Toole, who co-manages the Renaissance Canadian Bond Fund, an underlying fund in the Renaissance Optimal Income Portfolios. For June, Statistics Canada reported the creation of 31,800 jobs but also said the unemployment rate rose to 6% due to more people looking for work—it was the first time it surpassed that level since October 2017.

The “strong job growth” in both April and May, with about 270,000 jobs added, is “way above what’s needed to absorb the natural growth rate of the labour force,” O’Toole said.

Read: Unemployment rate rises in Canada and U.S. despite adding jobs

Along with positive labour trends, O’Toole expects the BoC “could argue easily that the economy’s been growing at least at trend—maybe above trend,” he said.

“You don’t need to have rates at a stimulative level, or a rate below the neutral level, to help the economy along,” he added, so there’s room for a hike.

Hiking now could also give the BoC room to cut rates later, O’Toole said, should Canada go through a recession in the next six, 12 or 18 months.

Reasons for caution

Currency is also a factor. While the loonie (trading around US$0.76 on July 9) is already sitting below US$0.85—what O’Toole considers fair value—BoC governor Stephen Poloz may want to hike to keep it that way, O’Toole said.

Poloz “has said there’s nothing wrong with having the Canadian dollar a little below fair value to [stimulate exports], but he’s well aware that Canadians travel a lot,” said O’Toole. “He doesn’t want the currency at too low a level, [where] it’s expensive when people go outside of the country for vacations.”

Read: Why investors should keep a close eye on the loonie

One reason is “consumer psychology is damaged when the home currency is well below what [consumers] think it should be,” he said, giving the central bank a reason to hold on future hikes if that were to occur.

The ongoing NAFTA negotiations are another reason for the bank to be cautious. The tone of these talks took a turn for the worse in June, said O’Toole, after which the Canadian government introduced retaliatory tariffs.

Read: What might cause trade tensions to ease

In a speech at the end of June, Poloz noted the Bank’s decision-making process will also include analysis of the effects of new mortgage-lending rules.

The high level of household debt and low rate of savings are factors the BoC will use to gauge the impact of interest rate hikes to date, said O’Toole. “Keep in mind Canadians have a lot of debt today. A 75 [to] 100 basis point rise in rates bites a lot harder today when household debt-to-income is at a 168% whereas, back in 2000, it was closer to 100%,” he said.

Read: Two cities saw housing affordability improve in Q1: RBC

The BoC may also look at other economic indicators, such as the Citi Economic Surprise Index, said O’Toole. As of late June, the index was at “a five-year low on Canada, meaning most of the economic data [was] coming in below expectations, so that’s not a good sign,” he said. (The index measures whether data releases have beaten or missed expectations in the past 90 calendar days.)

Still, he expects the BoC to raise rates as well as “guide the market” in this announcement. Following a July hike, O’Toole said, the central bank will then hold rates as it gauges the economy.

In the next 12 months, he said, the bank may hike twice at most.

BoC marches to own tune

The U.S. Federal Reserve is expected to raise rates four times this year, as indicated in its latest meeting minutes, and the ECB is planning to withdraw its stimulus program.


The BoC doesn’t have to follow the Fed or the ECB, especially since it doesn’t use quantitative easing, said O’Toole. He also finds Poloz is a different central bank governor than previous BoC leaders.

Poloz has said he relies on more qualitative factors, O’Toole said, adding the governor talks to companies and considers interactions he’s had with Canadian business leaders and consumers.

As for global pressure on the BoC, it’s also not a guarantee that the Fed will hike four times, and the ECB is taking it slow with normalizing its monetary policy, O’Toole said.

In coming months, O’Toole is monitoring the yield curve for a possible inversion, where the “short-term interest rates move above longer-term interest rates” and longer-term bonds have a lower yield than short-term ones. If that happens, particularly in the U.S., the Fed and BoC might pause their tightening efforts, he said, as such inversions often point to the possibility of a recession.

Also read:

Look beyond optimistic tone of BoC biz survey

At 0.1%, real GDP edges above expectations for April

Trade, mortgage lending rules to ‘figure prominently’ in next BoC rate decision

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Sharon Ho