What we learned from the Bank of Canada decision and how it will affect the currency market
1) Rates are going up in 2022
On November 26 in the House of Commons, Tiff Macklem said, "We want to be very clear-Canadians can be confident that borrowing costs are going to remain very low for a long time."
Maybe not.
The BOC is now forecasting that the output gap closes in 2022. Normally, that would mean a start to hiking about six months beforehand but Macklem has adopted the global central bank ethos of waiting for a full recovery before acting.
But if you look at the GDP forecast chart, it won't be long before we're back to prepandemic levels. Along with that, the BOC said we're only about 475K jobs short of Feb 2020.
A 'long time' and 'very low' rates are open to interpretation but that might mean a 1.00% overnight rate in late 2023, not rates at zero.
2) The outlook has dramatically improved
A year ago, no one knew the future and even among the vast array of prognosticators, no one I know predicted this kind of bounce back. Even during the waves in the virus over the past few months, economies have coped remarkably well.
The Bank of Canada is ready to embrace that. Today's rate decision could be titled "How we learned to embrace the recovery and stop worrying about the virus."
The GDP forecast for Canada was boosted to 6.5% from 4.0% in January. Estimates for the US, China and global growth were also significantly boosted.
3) The world will follow
Is Canada an isolated case or a sign of things to come elsewhere? It's a lively debate but I believe the BOC is suddenly in the vanguard.
I don't think central banks have any regrets about the actions they took a year ago but they may regret staking their credibility on pledges to keep rates low and overshoot on inflation. The combination of ultra loose monetary and fiscal policy has been incredibly powerful.
Increasingly, central bankers will see asset price inflation along with robust growth and decide that hiking rates by 50-100 bps isn't going to kneecap the economy, though the stock market won't like it. Even worse are bonds, which are yielding less than inflation and will soon be yielding less than overnight central bank rates.
4) Canada is in an amiable spot and so is CAD
What else would a CAD bull want?
- Commodity prices are high
- The reopening timeline is moving forward
- This week's Federal budget was stimulative
- Home prices are sizzling
- Global growth has been resilient and US stimulus will spill over
I wrote about all this in the BOC preview so nothing here is news to me, but what was notable is that Macklem didn't even try to soften the blow or talk down the loonie. There was no pushback whatsoever. That's a green light for the loonie. I continued to expect USD/CAD to hit 1.20 this year, the only change is that it will happen sooner.
