The overnight interest rate is widely expected to rise another 50 basis points on June 1 (to 1.5%) as the Bank of Canada continues its efforts to fight inflation. The rise will build on the BoC’s 50 basis point hike in April and 25 basis points in March, with further increases likely in the coming months. Inflation is rising at the fastest annual rate since the early 1990s. And the economy is running at full speed, as evidenced by persistently strong GDP growth and low unemployment for several decades. We expect GDP growth for the first quarter (which will also be released next week) to come in at 4.5%, above the BoC’s latest forecast of 3%. In this context, the path to at least a more “neutral” level of interest rates—estimated between 2% and 3% for the overnight rate—meets little resistance.
The question is whether rates need to rise above this neutral range to control inflation. So far, the surge in inflation has been as much the result of extremely strong demand as the limits of supply. Higher rates should help address some of this pressure. Indeed, the initial impact of rising interest rates is already being felt in the housing market, where resales have cooled considerably and prices have fallen for the first time since the start of the pandemic. But with other central banks (including the US Fed) also raising rates more aggressively, global spending and inflationary pressures should gradually ease. We expect the Bank of Canada to raise the overnight rate to 2.5% by October.
Monitoring data for the coming week:
We expect Canadian Q1 (2022) GDP to grow at a rate of 4.5% (annualized). Residential investment is expected to decline due to lower housing starts and slowing resale home markets. Net trade follows a large subtraction, with exports falling more than imports. But we expect consumer spending to rebound quickly after the disruption in service spending from the Omicron variant in January.
The second-quarter release of the Canadian Business Conditions Survey next week is expected to point to worsening capacity constraints for businesses in virtually all sectors, limiting their ability to increase production. Companies will likely signal their intention to raise product prices further as inputs, transportation costs and wages continue to rise faster, the latter underpinned by severe labor shortages.
US payroll employment is expected to continue to rise in May as widespread labor shortages add to wage pressures.