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BoC Rate Hike Prediction | CPI Data | Canadian Economic Outlook

Introduction: The Precursor to a 2023 Pivot

The highly anticipated Bank of Canada (BoC) interest rate announcement on January 25th is one of the most critical interest rate announcements in recent years. As Canada is faced with higher inflation, mortgages hitting the trigger rate, and a tumultuous stock market, the Board of Governors at the Bank of Canada are stuck between a rock and a hard place. Thus far, we have seen an aggressively hawkish central bank to tame the recent high inflation which has eventuated. However, between the BoC hiking lower than expected in October and with the growing narrative of a recession, I believe that we will see a less hawkish BoC. I am estimating that the Bank of Canada will pursue a rate hike of anywhere between 0-25 basis points. To begin with, critical leading inflation indicators such as commodity and equity prices are pointing towards a lower future Consumer Price Index. Secondly, the interest rate spread on short and long-term government debt is a signal that big institutions are believing that the current inflationary pressures are only cyclical. Finally, the corresponding wealth effect driven by higher interest rates and lower asset prices could put us into a recession as consumers and businesses willingness to spend or invest in more capacity has become depleted.

The Consumer Price Index: A Lagging Indicator

The Bank of Canada has two primary objectives, maintaining price stability and keeping unemployment low. The consumer price index (CPI) is the weighted average prices of goods/services at a given point in time. The increase in percentage terms of the CPI is widely considered to be the headline inflation rate. The Bank of Canada over the last year has been making aggressive interest rate increases in order to tame what has been price instability with high increases in the CPI. Currently, Canada’s CPI is hovering around 6.1% which is considerably lower than the high of 8.1% we saw in June of 2022. This indicates that the central bank’s rate hikes are having an impact on inflation.

In addition, it is expected that the Board of Governors at the BoC are competent economist and understand that the consumer price index is a lagging indicator, meaning that the CPI usually fails to incorporate economic contagions until after the fact. Given that the BoC is encompassed by competent economists that look at the right leading indicators of inflation, the central bank will acknowledge that anticipated inflation should fall without the need of an interest rate hike. The first leading indicator of inflation is commodity prices because they are direct inputs for businesses. During 2022, as inflation was going up commodities have been falling precipitously from their highs. Lumber, a commodity which price is typically correlated with economic activities such as construction, home building, and home renovations, has fallen to its lowest price since the pandemic.

Lumber prices

Moreover, oil which is another key input for many businesses has fallen 34% from its 2022 highs.

Oil prices

The next leading indicator for inflation numbers is asset prices. Asset prices are linked to inflation because the corresponding wealth effect is linked to aggregate demand. If we look at the S&P TSX, we see that the largest Canadian stock index is down around 3% on a year-over-year basis, however, the index was in correction (a drawback greater than 10%) territory a couple of times during the previous fiscal year. In addition to equities, housing weakness has begun to occur with housing price growth slowing down to next to nothing.

Canadian Housing Index

Therefore, we have declining input costs on the supply side combined with stagnant-to-declining asset price growth on the demand side indicating that CPI will be slowing down soon.

Interest Rate Spread: Yield Curve Inversion

The second reason I think the BoC will be less hawkish than expected is the interest rate spread on government debt. As of today, the 2-year, 10-year yield spread is around 76.1 basis points, with short term government debt yielding a higher return than longer term bonds. Short term government yields are generally influenced by central bank policy, whereas long-term debt may be influenced by inflation and economic growth expectations from bond vigilantes. The yield curve inversion is indicative of the institutions believing that inflation is cyclical and not secular, otherwise, yields on long-term government debt would be much higher. Furthermore, the yield curve has predicted a recession 86% of the time, recessions are often deflationary. Therefore, the current government yield curve is indicating inflation will come down, giving no reason for the central bank to tighten.

Business and Consumer Sentiment: Capitulation is on The Rise

The final reason I think the BoC will be more neutral with policy is because businesses and consumers are beginning to capitulate to the previous rate hikes. Business confidence hasn’t been as low since the pandemic and consumer confidence is also falling very quickly. With businesses being less confident about their environment it means they could be unwilling to invest into productive capacity, indicating that business owners expect lower demand.

Business Confidence

On the other hand, with consumers feeling less confident about the economy, the marginal propensity to consume decreases and would also lead to declining demand.

Consumer Confidence

Therefore, we think that the central bank is aware that consumers and businesses might be capitulating to the higher rates, making them reluctant to hike rates again.

Risk to The Thesis: Robust Labour Market

The factor which could potentially make my thesis wrong is the labour market. Looking at the current Canadian unemployment rate, we see that the unemployment rate in Canada is lower than it was pre COVID.


Due to unemployment being so low in Canada, the BoC doesn’t need to choose between its two mandates. Therefore, the BoC may proceed with more hawkish monetary policy if they think that they can fulfill both mandates successfully doing so.

Conclusion: Inflation is a Back Burner Story

In conclusion, I exist in the camp of a central bank pivot, and I believe that the next announcement January 25th will be a precursor to what will be a much different change of tone from the BoC in the coming fiscal year. Based on my belief that there is a high probability that inflation goes back down to 2% by the end of this year and that these interest rate hikes appear to be taking us into a recession, I think that the Central bank will pivot. Overall, I think the Canadian economy has a gloomy outlook in 2023 and that people will be looking at the central bank for support come Q3 of 2023. I stand by my macro thesis, hold U.S dollars.

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