Bank of Canada shocks with giant rate hike!
Canada’s central bank delivered a monster rate hike as they got serious about fighting inflation on Wednesday. The bank estimates that annual CPI will annualise at 7.2% in 2022 and decided that the best way to get ahead is to hike rates by a full percentage point, 25bps higher than the 75bps hike that was expected. The Canadian interest rate jumped from 1.5% to 2.5%.
All else equal, a currency would be expected to strengthen after a surprise hawkish move, and yet if you look at the USDCAD daily chart, it’s hard to pick out the release.
It’s at the top right, the bearish engulfing that tested the 20 day moving average from above before resuming the uptrend the following morning. Zooming in, the picture is clearer.
The initial bearish reaction quickly faded. The dollar wrecking ball is still swinging, and even an ultra-hawkish Bank of Canada isn’t enough to stop it.
However, the CAD remains strong against others, especially JPY.
It was, and the price is back at that level again now. Here’s the chart from June:
Compared to now:
The Bank of Japan still hasn't reacted either, sticking resolutely to their low rates policy stance.
The Bank of Canada explained that their decision was down to three key considerations:
- First, inflation is too high, and more people are getting more worried that high inflation is here to stay. We cannot let that happen. Restoring price stability—low, stable and predictable inflation—is paramount.
- Second, the Canadian economy is overheated. There are shortages of workers and of many goods and services. Demand needs to slow so supply can catch up and price pressures ease.
- And third, our goal is to get inflation back to its 2% target with a soft landing for the economy. To accomplish that, we are increasing our policy interest rate quickly to prevent high inflation from becoming entrenched. If it does, it will be more painful for the economy—and for Canadians—to get inflation back down.
- With these important considerations in mind, the Governing Council decided to front-load the path to higher interest rates today.
Summing up, the hope is that more interest rate pain in the short-term will prevent inflation from becoming entrenched and causing a longer-term issue. For the Canadian dollar, the energy and the general commodity outlook could weigh heavily. EIA data yesterday showed that US gasoline demand was at just 8.06 million barrels per day. That’s the lowest seasonal level since 1996. Looking around the world, economic concerns are prevalent, and all could weigh on global energy demand. There are also concerns about the Canadian economy’s sensitivity to interest rates. The abrupt turn in the housing markets is a risk, and questions surrounding how a highly indebted economy will cope with higher debt-servicing costs have also come to the fore. Only time will tell how this resolves.
Not investment advice. Past performance does not guarantee or predict future performance.
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