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The Bank of Canada increased its overnight interest rate by 25 basis points in its ongoing effort to tackle persistent inflation. Anthony Okolie speaks with Alexandra Gorewicz, Portfolio Manager, Active Fixed Income, TD Asset Management, about the outlook for central bank policy and the economy.
[AUDIO LOGO] Alex, as expected, the Bank of Canada hiked interest rates 25 basis points and signaled a pause on further hikes for the time being. What's your take on the decision? Well, Tony, it's clear that the rate hikes that have been delivered to date, which is really mostly over the past 12 months, are starting to have an effect. If we look at the updated projections and the monetary policy report for the Canadian economy, the Bank of Canada has slashed its GDP forecast for 2023 in half from 1% to 0.5%. So it's clear that the data is coming in a little bit weaker than they were previously expecting. And they've also, on the back of that, marginally revised their inflation forecast for this year to 2.6% while still expecting to get back to the 2% target by next year. So really, this was the bank's way of saying, we've done our job, and now we need to wait and see if the data continues to come in line with expectations or if we have to revise GDP and inflation lower. So do you believe that the Bank of Canada is done hiking rates at this point? I believe that now is a good time to take stock of what they've done and to understand what risk factors beyond their control might shape the evolution of inflation going forward. But as long as they maintain their current policy stance at 4.5%, the policy rate at 4.5%, they can afford now to wait and see how inflation continues to come down and to what level. OK. So now we know what the Bank of Canada is telling us about the inflation and the economy. What is the bond market telling us right now? Because sometimes they're a bit at odds in terms of their direction. The bond market absolutely supports a pause at this point. I mean, up until the stellar jobs print that we saw a few weeks back, the bond market wasn't even sure whether the Bank of Canada needed to hike rates again. But after that jobs print, they said, OK, one more rate hike. One more to go. One more to go, 25 basis points. There you go. It's been delivered. And now the bond market supports a pause. Now, where they are at odds, and they have been for some time, is that the Bank of Canada, like other central banks, has said, we don't anticipate that we're going to pivot quickly. We need time. And you can't change time. You can't make it come faster. You need time to see whether inflation actually does come down to target. And the bond market has gotten ahead of that and said, no, we think you're going to start cutting rates in the second half of this year. So this is where they're still at odds. The bond market continues to expect that easing to come in for the second half of this year. But Bank of Canada, for now, is saying let's be patient. Let's just pause and see. Take some time. That's right. I want to talk a little bit about risks, because we know inflation obviously continues to be a story, the recession worries coming into 2023. What do you think are the biggest risks right now to the Bank of Canada's outlook? I think the biggest risks are beyond its control, and they're global in nature. So on the one hand, what could put renewed pressure on inflation is the pivot that we've seen in China from their zero-COVID policy. Will that actually generate the kind of economic activity that puts pressure on global commodity prices, that in turn puts pressure on global inflation? So that is one risk where perhaps the pause might end up manifesting itself in additional rate hikes down the road for Bank of Canada, although, at the moment, that's still a lower-probability outcome. And then on the other side, risks that perhaps might see the bond market be right about the Bank of Canada's need to ease rates later this year is if we get a more aggressive slowdown globally, so in other words a deeper recession than the mild or run-of-the-mill type of recession that markets currently expect. And the way that you could get that is maybe through some kind of financial stress globally that could emanate, for example, from Bank of Japan's pivot to tightening monetary policy. They're still very much in easing mode. Or perhaps it comes from political sources like the US debt ceiling, the debate in the US at the moment, and how that might play out in financial markets. Both of those sources of risk could tighten global financial conditions and then create a slowdown beyond what the Bank of Canada is currently anticipating. Very good perspective there. What about the outlook for the loonie? Where do you think it's headed over the next little while? Well, the immediate reaction for the Canadian dollar was to weaken on the back of this, really, because of that pause that the Bank of Canada has indicated. But really, it will be less about the Canadian dollar and more about the US dollar this year. After a very strong rally across all major currencies last year, the US dollar, with the Fed now approaching the end of its rate hike cycle, has turned the corner, and it's showing signs of weakness. Now, how persistent that is, whether you have some of these stresses come through in global financial markets, et cetera, will ultimately dictate how the US dollar behaves. But at the moment, it appears that it is on a downward trajectory. So although the Canadian dollar could weaken now that the Bank of Canada's paused and other central banks are still tightening, there are offsets, particularly with respect to the US dollar. So we could be in a range-bound environment here. Alex, thank you very much for your time. Thanks, Tony. [AUDIO LOGO]