TORONTO (Reuters) - Top Bank of Canada officials’ recent assertions that a pair of 2015 interest rate cuts did their job in cushioning the economy from collapsing oil prices appear to be paving the way for a tightening move as soon as next month.
By singling out the cuts, termed “insurance” at the time, the central bank appears to be making the case that it can now remove that 50 basis points of accommodation even as progress toward meeting the inflation target that typically drives its policy remains elusive.
Indeed, the bank’s preferred measures of inflation are all well below the 2 percent target.
Still, comments from the bank’s top two officials this month are seen as signaling they would be comfortable cancelling the insurance policy soon.
Canadian currency and money markets reflect increasing certainty that the first rate hike in nearly seven years is not far off. The Canadian dollar is up 4 percent against its U.S. counterpart in June, the biggest monthly gain in 15 months, while money market rates have shot up at their fastest since 2010, when the Bank of Canada last raised rates.
“The low-hanging fruit is to take back the two cuts,” said Richard Gilhooly, head of rates strategy at CIBC Capital Markets.
“The removal of insurance eases is not linked to any particular employment print; it is not linked to one month or two months data,” he said. “ ... It has done its job, and I think that’s why the market is reacting the way it is.”
Data from the overnight index swaps market showed traders see a 57 percent chance of a rate hike next month, up from 50 percent before a Bank of Canada survey indicating companies were more optimistic about sales and exports.
Chances of an increase were just 20 percent after last week’s consumer price index report showed subdued inflation. BOCWATCH
“Whatever you believe the Bank of Canada was planning on doing, the miss on CPI is not going to dissuade them,” said Andrew Kelvin, senior rates strategist at TD Securities. “Nor is the move lower in oil prices that we’ve seen.”
Oil has traded recently at 10-month lows. But the Bank of Canada has said the economy has largely adjusted.
The move in rates from 0.50 percent to 1 percent will be a reaction to “observed growth” in the economy, Kelvin said.
Canada’s economy grew at an annualized 3.7 percent rate in the first quarter after a strong expansion in the second half of 2016. The central bank expects it to continue to run at a pace that will help drive inflation higher.
Senior Deputy Governor Carolyn Wilkins was clear in her recent speech “that what matters is the outlook for inflation, not so much what is going on now,” said Desjardins senior economist Jimmy Jean.
Service sector inflation is already running in excess of 2 percent and is a better indicator of domestic inflation pressures, analysts said.
“We think the 50 (basis points) is done,” CIBC’s Gilhooly said, adding that the central bank might do more if inflation starts to move higher.
Reporting by Fergal Smith; Editing by Dan Burns and Lisa Von Ahn