In this article, we explore what the immediate future holds for the Bank Of Canada’s monetary policy.
Specifically, we’ll look at Canada’s rate of inflation – and why it’s prompted some market commentators to expect a hike in September.
However, we’ll explain why this is more likely to happen in October.
After you’ve read this article, you know what to expect from the Bank Of Canada in the coming months – and how this could affect CAD.
Here’s what the article covers:
- Canadian CPI Inflation Data
- Market Expectations
- NAFTA Negotiations
Canadian CPI Inflation Data
The markets were caught off guard last week. Canadian CPI inflation data ballooned past market forecasts (0.1%) for July, coming in at 0.5%.
This saw the annual inflation rate jump from 2.5% to 3% – it’s highest since 2011.
Unsurprisingly, this has led to speculation that the Bank Of Canada could be forced to hike its rate at a faster pace than originally anticipated. It saw the Canadian dollar climb to C$1.3070 against the US dollar.
Now, what you need to know that is that the Canadian central bank is in a cycle of hiking rates. Since 2017, it has increased interest rates on four occasions. Currently, the benchmark interest rate stands at 1.5%.
The last rate hike only came in July 2018. With this in mind, most economists anticipated that another rate hike would come in October 2018.
So with inflation at 3%, surely we’ll see the rate hike brought forward to September, right?
An October hike is still the most likely. In fact, at the time of writing, the markets deem that there is an 80% chance of another Bank Of Canada hike rate in October.
(N.B. Remember, higher interest rates can curb the rate of inflation by tightening an economy’s money supply. There’s a detailed explanation of this phenomenon in this article.)
The reason why is quite simple. When we drill down to analyse the average core inflation measures, we can see that only increased from 1.97% in June, to 2% in July. Clearly, this is a sustainable rate and is in line with the Bank Of Canada’s targets.
It’s also important to note that the Bank Of Canada places more weight on core inflation data, rather than CPI inflation data.
While both are important, CPI inflation data can fluctuate for fleeting reasons. In fact, that’s what has happened on this occasion. The jump in the CPI inflation rate has been attributed to higher gas prices.
So while CAD jumped on the prospect of faster rate hikes, the monetary policy path is likely to remain the same.
However, something that could change that monetary path in the coming months is NAFTA.
The North Amercian Free Trade Agreement enables barrier-free trade between Canada, the United States and Mexico.
Since his election in 2016, President Trump has prioritised renegotiating NAFTA to reduce the US trade deficit. Part of his strategy to secure a favourable outcome has been to introduce and threaten further trade tariffs.
An example of this came earlier this year. The US introduced import tariffs on Canadian steel (25%) and aluminium (10%). Clearly, this is a move that has big implications for Canadian manufacturing.
In retaliation, Canada has introduced import tariffs of its own on a range of US products. This includes a 25% tariff on US assorted metal products.
As this situation continues to develop, CAD could enter periods of volatility. If NAFTA negotiations stall, we can expect downward pressure on the CAD.
Don’t Bet On A BOC Hike In September
In this article, we’ve explained why the Bank Of Canada isn’t likely to hike its interest rate in September.
Particularly, we’ve detailed why – despite a recent high inflation reading – a hike is still more likely to happen in October.
In addition, we’ve highlighted how ongoing NAFTA negotiations could change the Bank Of Canada’s monetary policy direction.
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