Outlook is good enough to keep BoC in policy normalisation mode – ING

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“Current market expectations imply that a Bank of Canada rate hike this year is unlikely. But in our view, the outlook is good enough to keep the central bank in policy normalisation mode,” ING analysts argue.

Key quotes

“Following the Bank of Canada’s (BoC’s) more dovish tone in December and our view that the Federal Reserve will take a pause on tightening policy in the first quarter, Canada’s 1Y swap rate has been experiencing downward pressure. It currently (below) indicates there’s around a 60% chance of one full rate hike in the coming year, whereas back in October, markets had two full rate hikes priced in.”

“The BoC has indicated it wants to take the policy rate to its neutral range (2.5%-3%, based on-at target inflation), to achieve the inflation target. However, the lagged effect of rate hikes – the central bank’s workhorse model states it takes around six quarters until the full impact of an increase is felt- suggests the housing market correction is far from over. As a result, household activity could be under pressure, as homeowners start to see one of their largest financial assets lose value.”

“Nevertheless, the unemployment rate is at a four-decade low, core inflation has remained around the bank’s 2% target and our expectation that there will be a constructive U-turn for business activity (outside of the energy sector) suggests that the above downside factors shouldn’t push the central bank into hitting the brakes just yet. We see a rate hike in both the third and fourth quarter, but believe the risks are skewed to the downside, especially given our view that the Fed is likely to moderate policy tightening in the US.”

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