Investors, looking past the COVID-19 pandemic, are betting that the Bank of Canada could be among the first major central banks to hike interest rates, signaling new governor Tiff Macklem’s success so far convincing the market not to expect negative rates.
Money market data shows investors have moved away from pricing in additional easing by the Bank of Canada and instead see a steady profile for rates this year and next, with about a 50% chance of a rate hike in 2022. .
The Federal Reserve, which has been pressured by U.S. President Donald Trump to cut rates below zero, is not expected by money markets to hike until at least 2023.
“The Bank of Canada has done a better job than some other central banks of quashing speculation around further rate cuts,” said Andrew Kelvin, chief Canada strategist at TD Securities.
“If you think that the economy did hit bottom in April, a rate hike in two years … is a plausible outcome I think,” Kelvin said.
After the Bank of Canada slashed interest rates in March to a record low of 0.25%, speculation mounted that it would join central banks in Japan and Europe in setting rates below zero.
Just last month, the Canadian dollar slumped as some investors mistook a comment by Macklem, on the day he was named the governor, as putting negative rates on the table.
Sub-zero rates lower borrowing costs and could help exporters if the Canadian dollar were to decline, but they also hurt lending margins for banks and penalize savers.
Some economists argue the experience of Europe and Japan shows that negative rates are not effective at boosting economic growth. Alternatives for the Bank of Canada if it needs to add stimulus include adding to the size of its bond-buying program.
Both Macklem and his predecessor Stephen Poloz have said they see 0.25% as the floor for rates. That could have headed off some potential headaches.
If negative rates “were to get priced in and the BoC didn’t meet the market expectation, then the BoC would be disappointing markets,” said Greg Anderson, global head of FX strategy at BMO Capital Markets. It “would likely trigger an equity decline and CAD rally at a really bad moment.”
Money markets could also be signaling confidence that adequate fiscal and monetary policy stimulus has been put in place to help Canada’s economy recover, said TD’s Kelvin, adding that the BoC will not want to encourage excessive borrowing from already heavily-indebted Canadians.
“I wouldn’t be surprised if the Bank of Canada was a little bit more eager (than other central banks) to move out of emergency rates when they are able to,” Kelvin said.