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The BoC Abandons its Rate Hike Bias


Two years ago the Bank of Canada (BoC) predicted 2% inflation and normalized growth by the end of 2013.

Three years ago the BoC predicted 2% inflation and normalized growth by the end of 2012.

Four years ago the BoC predicted 2% inflation and normalized growth by the end of 2011.

Now, the BoC predicts 2% inflation and normalized growth by the end of 2015.

Do you see a pattern?

Today the Bank threw in the towel and stopped hinting at future rate hikes. (One less prediction to get wrong.) It had held that rate hike bias for 18 months.

Why can’t the BoC get it right?

Well, as Governor Stephen Poloz put it, “Policy is dependent on the data flow.” And the BoC is using similar data as everyone else—much of it backward looking.

As one such example, Poloz noted today that:

…slower growth in household credit and higher mortgage interest rates point to a gradual unwinding of household imbalances.

But interest rates are not predictive data and increases can be fleeting. We’ve seen that lately with 5-year swap rates (which influence fixed mortgage rates) already giving back 50% of their summer increase.

(Click chart to enlarge)

As it stands, inflation lies just above 1% (the BoC likes it near 2%) and annual economic growth is limping along at a skimpy 1.6%. That made it an easy call for the Bank to hold Canada’s key lending rate at 1% today.

“…The fact that inflation has been persistently below target means that downside risks to inflation assume increasing importance,” the BoC said in its statement today. But it nonetheless remains leery about stimulating the economy further and fuelling:

a) more debt accumulation, and

b) a hotter housing market (which it says now has “renewed momentum”).

The BoC has resigned itself to playing a game of patient optimism. Its self-limited policy options have it waiting and hoping for the economy to kick into high gear (or any forward gear besides first gear).

In the meantime, don’t be surprised if we continue to get teased by 2-3 months of positive growth here and there, and then disappointed by what comes next.

The markets (including overnight index swaps — which trade on BoC rate moves) boiled all of this news down to one thing: no prime rate change through 2014.

In addition, bond yields—which lead fixed mortgage rates—sank to a 3-month low. That could pull down long-term fixed rates at least 10-15 basis points.

As for variable rates, they remain near prime – 0.50%, with a slight trend towards bigger discounts. Given that, and the fact that the BoC now admits the odds of a rate cut are the same as the odds of a rate hike, we’ll likely see VRMs become a bit more popular.

Sidebar:  The final BoC rate meeting of 2013 is December 4.

Rob McLister, CMT