Speculation grows for July rate hike

Speculation that the Bank of Canada is preparing to raise its key interest rate continued to ramp up after governor Stephen Poloz’s latest comments to a German newspaper published Tuesday.

While talk about a possible rate hike by the Bank of Canada has increased, inflation in Canada has remained low.

However, Poloz said in the interview with Handelsblatt last week that there is a substantial lag between when the economy approaches full capacity and when that begins to translate into inflation.

He said if the central bank only watched and reacted to inflation, it would never reach its inflation target and it would always be two years behind in the reaction.

Poloz noted that he has to look at other indicators in the models that predict inflation.

Business outlook survey

One of those indicators is the Bank of Canada’s business outlook survey, released last Friday.

Read: Canada’s GDP and biz sentiment provide a reason to celebrate

“This is a modest survey of 100 CEOs, but the BoC uses it as an anecdotal and fresher set of information to complement data,” says Derek Holt, vice-president and head of capital markets economics at Scotiabank, in an economics update.

The survey’s optimistic tone reinforces Scotiabank’s hike expectations for July and a greater-than-priced tightening path thereafter.

For example, the survey reveals a big jump in business outlook for future sales — a 10-point jump to the highest point since the early days of commodities correcting back in Q3 of 2014.

“What this does is reinforce that the oil shock is done in the mind’s of Canada’s C-suite respondents,” says Holt. “It’s so yesterday’s news.”

Further, the survey indicates positive numbers for investment, hiring intentions and labour shortages.

“This is the strongest reading for hiring intentions in the two-decade history of the survey,” says Holt, and that will inform the BoC’s wage growth forecast. With Ontario and Alberta increasing their respective minimum wages, Holt expects wage inflation in 2018.

“That’s going to be a big deal at the BoC,” he says. “If [business is] hiring more and we’re transitioning to seeing people paid more, then in a Phillips curve sense that would reinforce expectations for a bottoming of core inflation measures this year and some upward pressure into next year and beyond.”

He also notes that after the survey was released, 2-year yields jumped by about 2 basis points.

Loonie

As the Bank moves closer to hiking rates, the loonie has been on a tear. But “this may be as good as it gets with so much already priced in for the BoC,” say senior economist Andrew Grantham and director Royce Mendes, both of CIBC, in a weekly economics report.

They expect gradual tightening in part because exports, excluding energy, haven’t been strong, despite a pickup in global growth.

“With that backdrop,” say Grantham and Mendes, “Governor Poloz won’t want to see the C$ appreciate too much more. As such, we see the loonie giving back a little of its recent strength in the next couple of quarters.”

CIBC forecasts a hike in October, but also says its conviction on timing isn’t strong, given “the economic impacts of small variations in timing aren’t material.”

The Bank of Canada’s key interest rate target has been set at 0.5% since 2015. The central bank’s next rate announcement is set for July 12.

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