Macklem hand April 12

Bank of Canada Governor Tiff Macklem will be doing some soul searching ahead of the June 7 rate decision.

In January, the central bank hiked rates to 4.50% and said this:

Governing Council expects to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases. Governing Council is prepared to increase the policy rate further if needed to return inflation to the 2% target, and remains resolute in its commitment to restoring price stability for Canadians.

Since then, it's left rates unchanged at meetings in March and April. The minutes of the April meeting showed the BOC discussing a hike and that members "agreed there was a sense that economy was proving a little stronger than expected early in the year."

Today, we got concrete evidence of that with Q1 GDP up 3.1% annualized or 0.8% q/q. That compares to the 2.3% BOC forecast.

Notably, April advance m/m GDP also rose 0.2 pp, which is a faster pace than the 1.0% annualized projection for Q2.

The BOC has an exclusive mandate on inflation and that will be the main part of the debate. In April, the BOC said it expects CPI inflation to come down to around 3% in the middle of 2023 with it falling to the 2% target at the end of 2024.

From the latest Monetary Policy Report:

Goods price inflation is falling due to past declines in gasoline prices, improvements in global supply chains and moderating effects of high interest rates on global demand. In contrast, shelter price inflation is still high. Inflation in the prices of many other services also remains elevated. This reflects the strength in the demand for services as households catch up on what they missed during the pandemic as well as ongoing tightness in the labour market.

Unlike the Fed, the BOC won't get another CPI report before their decision. Instead, they will be thinking about the April report, which showed prices up 4.4% y/y compared to 4.1% expected, with prices up 0.7% m/m.

Since then, the rates market has been flirting with a BOC hike and those odds have risen to 38%, from 27% before the data. Another option is that the BOC tees up a hike at this meeting to be delivered in July or September. The market has priced in about a 75% chance of a hike by September.

What might make the BOC push back against that is pain among people with mortgages. The Canadian market works on variable and five-year fixed mortgages, so every month that rates stay high, Canadians are hit with higher rates and renewals. Over time, that will suffocate consumer spending and the BOC may be tempted to wait. That dynamic also raises the odds of a policy mistake and the BOC being forced to cut later.

For USD/CAD, the pair has sunk to 1.3622 from 1.3645 before the data but it's wrestling with a rout in oil prices this week as well.

Overall, I expect the Bank of Canada to walk a fine line with this decision. They will pivot to more-hawkish language than the current guidance and buy time for a slowing economy to appear in the data.