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The Bank of Canada will likely holster its “guns blazing” approach to rising interest rates in December as heavy crude prices crater and previous hikes hit the economy earlier than expected, according to economists at CIBC.
The central bank boosted its key interest rate by 25 basis points to 1.75 per cent on Oct. 24, while signalling back-to-back rate hikes could be in the cards by removing the word “gradual” from its lexicon. Avery Shenfeld, chief economist at CIBC Capital Markets points out this was mere days before oil prices “did a full face plant, making a December rate hike unconscionable.”
“Forgive the Bank of Canada if they end up sounding a bit sheepish in December. They came out with guns blazing in October,” he wrote in a note to clients on Tuesday.
Western Canadian Select (WCS), Canada’s heavy-oil benchmark, has plunged 74 per cent since mid-May to US$15.20 per barrel as of 9:17 a.m. ET on Tuesday.
The price shock prompted Alberta Premier Rachel Notley to appoint a panel of three envoys to work on a short-term solution. Some business leaders in the energy patch are calling for the province to impose a broad-based production cut to stabilize prices. Others say such a move would spook investors, irritate United States trade relations, and jeopardize TransCanada Corp.’s (TRP.TO) Keystone XL project.
“Even before oil’s hasty retreat, and even if it manages to rebound on OPEC production cuts in 2019, there were reasons for Canada’s central bank to be cautious in terms of just how fast, and how far, they take their current tightening,” Shenfeld wrote.
He said while core inflation is near the Bank’s two per cent target, an acceleration in wages is “nowhere to be found.” Meanwhile, he sees the impact of five rate hikes since the middle of last year materializing faster than in past economic cycles.
“The hikes to date are starting to bite on interest rate-sensitive sectors,” Shenfeld wrote. “A move to three per cent, the supposed neutral rate, would have this rate hike cycle eclipse all others since the mid-1990s. Sure the level for rates would be low, but the hit to a much more indebted household sector would be anything but mild.”
Shenfeld’s colleague Royce Mendes notes the Bank of Canada’s macro model suggests monetary shocks lag six quarters behind a rate decision. But this time, he sees “there’s already pain being felt,” even though the first rate hike in this cycle, let alone the ones that followed, was administered less than six quarters ago.
Housing activity and auto sales have been under pressure, due in part to higher interest rates. Other durable goods categories like building materials, electronics and appliances have slowed in contrast to broader retail sales.
“The fact that the effects are showing up sooner this time around could simply be a sign that the storm will pass quicker,” Mendes wrote in a note to clients on Tuesday.
He expects the Bank of Canada will push its key rate higher “a couple more times early next year” if growth remains healthy and Ottawa introduces material measures to improve Canada’s competitive position.
“But, thereafter, the effects of higher interest rates will have a greater bite on Canadian growth than the central bank now expects, pushing the Bank into a holding pattern on rates,” Mendes wrote.
“Our call for a peak near 2.25 per cent overnight rate is near the bottom end of the consensus, giving the Bank of Canada credit in advance for seeing it the same way as the data roll in” wrote Shenfeld.