The Bank of Canada will deliver its first rate announcement of the year this week, where markets and economists overwhelmingly expect a 25-bps rate hike.

Such a move would be the Bank’s eighth consecutive hike since it began its policy tightening back in March, and would bring the overnight target rate to 4.50%. It would also imply a prime rate of 6.70%, a level not seen since 2001.

“Canadian central bankers will have had seven weeks to mull over whether rates need to be pushed even higher,” noted Royce Mendes, Managing Director and Head of Macro Strategy at Desjardins.

“Focusing on the metrics that the Bank of Canada has highlighted in recent communications, it doesn’t seem like enough progress has been made to hit the pause button [this] week.”

During that time, the Bank has received economic data from December, including inflation, which continued to decelerate to 6.3% from a high of 8.1% in June.

While that’s a positive development from the Bank’s perspective, it also received stronger-than-expected employment data, which showed the economy added 104,000 new jobs last month—85,000 of which were full-time.

While employment is a well-known lagging indicator, the fact that employment was “racing ahead” in the fourth quarter is something the Bank is likely to take into consideration when it meets this week, Mendes noted.

“That doesn’t mean that the Bank of Canada should keep ratcheting up rates until all these factors show progress. The lags inherent in monetary policy need to be respected,” he wrote. “But a 25-bps rate increase coupled with another vague suggestion that the Bank of Canada is open to pausing thereafter seems like the most probable course of action.”

What the forecasters are saying…

On the size of the hike:

Desjardins: “The Bank of Canada is looking to hit the pause button soon, but central bankers won’t be able to do so just yet. Given the ongoing strength in the economy and the stickiness of underlying inflationary pressures, look for monetary policymakers to nudge rates up another 25bps [this] week.”

On inflation:

TD Economics: “Despite signs from the consumer and business surveys that Canadians are tightening their belts as they brace for recession, the battle against inflation has not turned enough for the BoC to declare victory.”
Desjardins: “Inflation expectations…remain uncomfortably high. Despite falling gasoline prices, Canadian consumers still believe inflation will be tracking 7% over the coming year, virtually unchanged from their responses three months earlier. It’s the same story for inflation expectations over the next two years, which remained stubbornly high at 5%.”

On jobs:

RBC Economics: “Persistently low unemployment is pushing wages higher and threatening to put a floor under future inflation rates. But softer labour markets in 2023 are likely already baked in as the aggressive interest rate hikes from 2022 filter through to household and business purchasing power/decisions with a lag.”

On rate cuts:

National Bank of Canada: “In our view, interest rates will not need to be kept at current levels for very long to brake inflation and we accordingly expect the Bank to be obliged to lower them in the second half of [2023].”

On the impact on the housing market:

RBC Economics: “The lagged impact of the 400 basis points of BoC rate increases in 2022—the most aggressive hiking cycle in decades—is still filtering through to household and business borrowing costs. We expect household debt servicing costs to rise to record levels by mid-2023. Housing markets have already softened significantly.” (Source)

The latest rate forecasts

The following are the latest interest rate and bond yield forecasts from the Big 6 banks, with any changes from their previous forecasts in parenthesis.

Looking ahead to next year, analysts expect the Bank’s overnight target rate to end 2024 at 3.00%.

	Target Rate: Year-end ’23	Target Rate: Year-end ’24	Target Rate: Year-end ’25	5-Year BoC Bond Yield: Year-end ’23	5-Year BoC Bond Yield: Year-end ’24
BMO	4.50%	NA	NA	3.00%	NA
CIBC	4.50% (+25bps)	3.00%	NA	NA	NA
NBC	3.75%	3.00%	NA	2.65% (-35bps)	2.70% (+5bps)
RBC	4.50% (+25bps)	3.00%	NA	2.75% (-40bps)	2.55% (-20bps)
Scotia	4.00% (-25 bps)	3.00% (-100 bps)	NA	3.35% (-55bps)	3.15% (-40bps)
TD	3.75%	2.25%	NA	2.60% (-50bps)	2.35% (-25bps)