Markets underestimating risk of more BoC rate hikes: Citi

Citi Research says there's growing evidence the domestic economy has been stronger than expected and the housing market could be finding a floor, which might lead the Bank of Canada to continue hiking interest rates. THE CANADIAN PRESS/Sean Kilpatrick (The Canadian Press)

Financial markets are underappreciating the risk of interest rates moving higher in Canada and the U.S. despite recent volatility caused by the global banking liquidity crunch, according to a report from Citi Research.

The odds of another hike from the Bank of Canada in April have significantly fallen in recent weeks but Citi economist Veronica Clark is not taking the possibility off the table just yet.

"We also continue to pencil in a hike from the BoC in April, but if this proves to be too soon given lingering global uncertainty, we would still see risks that policy rates could rise further and would instead expect a hike in June," she said in a note, which was released on Friday.

She says her expectations will be adjusted according to factors including the Canadian inflation data due out Tuesday, messaging from the Federal Reserve next week, and the upcoming Business Outlook Survey in April.

The Bank of Canada paused its hiking campaign in March to assess how higher borrowing costs are impacting the economy, but Citi says there were "enough subtle signs" in the policy statement at the time for it to expect a quarter-point hike at the Apr. 12 meeting.

That is, until the collapse of Silicon Valley Bank and liquidity problems at a few other U.S. regional lenders, as well as Swiss banking giant Credit Suisse.

Regardless, Citi still sees some developments in the Canadian economy that could push the Bank of Canada to resume rate hikes.

Signs of a stronger-than-expected economy

Manufacturing sales posted a robust 4.1 per cent gain in January month-over-month, marking the latest in a string of datapoints indicating the Canadian economy kicked off the year stronger than many had expected.

"We would not expect this strength in manufacturing to last, but it is another instance of stronger data in early-2023 that we expect will also be evident in other activity data over the coming weeks," the report said.

"The BoC is thus likely to see even stronger early-2023 demand than previously assumed when they update MPR forecasts in April, another factor which could support an additional rate hike."

The latest Canadian Real Estate Association data also showed a small bump in February sales month-over-month, indicating buyers are re-emerging in the housing market, while the pace of home price declines moderated.

"For now, we would not expect much direct impact on Canadian banks' willingness or ability to lend due to financial stability concerns (although this remains a possibility especially if global sentiment around the banking system worsens). This suggests that lower yields, absent a substantial and timely pushback from global central banks, could lead to some near-term boost to demand for housing into the spring selling season," Clark said.

"Of course, prospects for weaker overall activity, including rising unemployment, have increased, but we would still not expect a broad and substantial slowing in the labour market until the second half of the year."

Michelle Zadikian is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.

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