Show Transcript
The Bank of Canada keeps its key policy rate unchanged, but moves forward its timeline for interest rate hikes amid worries over persistent inflation. Anthony Okolie speaks with James Orlando, Senior Economist, TD Bank, about the implications for Canada’s economy.
Print Transcript
- Well, the Bank of Canada kept its key overnight rate steady at 25 basis points as expected. But what was a bit of a surprise is that they moved up the timeline for rate hikes next year. James, lots going on. What stood out for you today?
- Yeah, I think you hit the nail on the head when it came to the pull forward of rate hikes. So the Bank of Canada is saying that they think the economy is going to eliminate all of that pandemic slack that's in the economy by the early or the mid quarters of 2022 opposed to the second half 2022. So what that means is they're getting markets ready for hiking rates. And they're doing that for a couple of reasons. One is we've seen-- obviously the employment report from last month was it was a blowout report.
But what we're also seeing and what they're acknowledging is that this high inflation that Canadians are experiencing right now, we're seeing inflation in everything, and they actually mentioned bacon prices going up significantly in their report. And it's not too often you hear about bacon prices in a Bank of Canada report. But essentially what's happening is that inflation is becoming very persistent. And it's impacting the economy significantly. So they're leaning into that saying that inflation is going to keep going the way it is. That's a sign that-- and we actually think the employment story is going to continue going the way it is-- that we're going to have to start hiking interest rates earlier than they previously thought.
- And it's interesting because we're starting to see some reaction from the bond markets. And now it seems that bond markets are pricing in more rate hikes in 2022. Where do you see interest rates going next year?
- Yeah, the bond market reaction today is significant. It's pretty wild what's going on today. Market participants are saying that we're listening to what the Bank of Canada is saying and we're starting to price out into bond yields. So bond yields are going up significantly this morning. We'll see what happens when Tiff Macklem takes the stage in a little bit of time. He might try to cool down markets a little bit right now. But what this means is that with government yields rising, that feeds through to all kinds of yields for Canada. It means that borrowing rates for corporations are going up.
People that have mortgages, if you're in variable rate mortgages, those are likely to go up. If you're looking to buy a new house, that five year mortgage rate it's going to be higher. Because what happens is that banks and lenders, they price that mortgage rate off that off Canadian bond yields. So that's where the cost of funds comes in. So when the Bank of Canada says they're going to hike rates, that feeds through to all kinds of borrowing for Canadians.
- And of course, we're going to move from the bond markets to the currency market. And just after the announcement we saw the Canadian dollar surge. Where do you see that loonie going in the next little while?
- Yeah so the loonie is really benefiting from two factors. One is that the fact that the Bank of Canada is likely going to raise rates significantly. At the same time, the Federal Reserve is sitting there being very patient. The Federal Reserve is the central bank to the world. So when they hike interest rates or they get more hawkish like the Bank of Canada is doing today, that feeds through to rates all around the world. So they need to be a little bit more patient. So with the Bank of Canada moving ahead of the Fed and bond markets reflecting that, that means international investors flood into Canadian bond markets to capture that extra yield.
Now, at the same time, energy markets are increasing significantly. We're seeing oil prices, WTI is up above $80 a barrel. We're seeing it through a number of a host of other energy commodities. Natural gas, for example. And all of these are beneficial to Canadian exports, right? And with Canadian exports surging that means that also pushes up the Canadian dollar. So the Canadian dollar has benefited from all of these factors going in the same direction. The question for people trading the currencies, how much further can we go? Is oil going to go towards $100? Or is it going to come back down to more manageable levels? Is Tiff Macklem going to walk away from a little bit of this hawkishness coming from the Bank of Canada?
Is the Bank of Canada really going to be able to hike interest rates significantly in front of the Federal Reserve? How much can they really hike ahead of the Federal Reserve? So all these questions are ones that people trading the Canadian dollar are really going to ask. In our view, it's going to be hard for the Bank of Canada to hike rates significantly ahead of the Fed. It's going to be hard for energy markets to continue to increase significantly towards $100 a barrel. And so as a result, the Canadian dollar is kind of in the sweet spot right now around $0.80.
- OK, so let's talk about some of the implications going forward. You touched on the real estate market. Why don't you start there? What are the implications for housing going forward?
- Well so the implications for housing is that we saw exactly what happened during the pandemic. Mortgage rates dropped, housing prices skyrocketed. OK. Now we're seeing the opposite is happening where mortgage rates are likely to increase over the next few months. They've already started increasing a little bit right now. And hopefully, you know, and this is part of the Bank of Canada's strategy most likely is that there's this macroprudential factor going on. The Bank of Canada doesn't want house prices to go up double digits like it did last year. It doesn't want that because what that does is it makes the Canadian economy really vulnerable to a downturn.
And so by pushing up rates through its communication, it's trying to make sure that housing doesn't accelerate, especially as we pass through the winter time period and into early 2022. And we always have that big surge in house prices. We have a lot of seasonality in Canada. So I think this is going to be a little bit of a headwind for housing. But overall when it comes to house prices and consistency of house price appreciation, we have this thing in Canada where we just don't have enough supply. Demand based on family formations based on immigration has consistently surpassed supply in Canada. And that's not changing.
So we always had this housing demand supply imbalance. And so that's why even though mortgage rates go up, you're not going to have some sort of housing correction in Canada.
- And what about the implications for the labor market? Are there any risks there in the near term?
- Yeah, absolutely. So I mentioned earlier that the most recent employment report showed a blowout level of employment gains in Canada. It was spectacular. We've actually gotten to pre-pandemic levels of employment in Canada. Whereas in the US, they're still way beyond getting to those pre-pandemic levels of employment.
The issue is, and the Bank of Canada's mentioned this too, is it's not equal. We know there's a lot of industries that are still suffering and a lot of people that are looking for a jobs. A lot of people that are in the labor force. They're looking but their businesses that they're associated with are not doing as well as if they wanted to. So there's a lot of inequality in labor markets.
The Bank of Canada, however, is hoping that as things open up, as vaccinations are clearly working to be able to allow us to open up the economy, as we get back in closer and closer to normal, all those jobs hopefully will come back. And they're really hoping that acceleration that we saw last month and employment is going to continue.
And so we're looking at a labor market that is heating up. And I think that's what they're hoping for because there is a lot of disparity based on the industry that people are working in.
- James, thank you very much for joining us.
- Thank you.
[MUSIC PLAYING]
- Yeah, I think you hit the nail on the head when it came to the pull forward of rate hikes. So the Bank of Canada is saying that they think the economy is going to eliminate all of that pandemic slack that's in the economy by the early or the mid quarters of 2022 opposed to the second half 2022. So what that means is they're getting markets ready for hiking rates. And they're doing that for a couple of reasons. One is we've seen-- obviously the employment report from last month was it was a blowout report.
But what we're also seeing and what they're acknowledging is that this high inflation that Canadians are experiencing right now, we're seeing inflation in everything, and they actually mentioned bacon prices going up significantly in their report. And it's not too often you hear about bacon prices in a Bank of Canada report. But essentially what's happening is that inflation is becoming very persistent. And it's impacting the economy significantly. So they're leaning into that saying that inflation is going to keep going the way it is. That's a sign that-- and we actually think the employment story is going to continue going the way it is-- that we're going to have to start hiking interest rates earlier than they previously thought.
- And it's interesting because we're starting to see some reaction from the bond markets. And now it seems that bond markets are pricing in more rate hikes in 2022. Where do you see interest rates going next year?
- Yeah, the bond market reaction today is significant. It's pretty wild what's going on today. Market participants are saying that we're listening to what the Bank of Canada is saying and we're starting to price out into bond yields. So bond yields are going up significantly this morning. We'll see what happens when Tiff Macklem takes the stage in a little bit of time. He might try to cool down markets a little bit right now. But what this means is that with government yields rising, that feeds through to all kinds of yields for Canada. It means that borrowing rates for corporations are going up.
People that have mortgages, if you're in variable rate mortgages, those are likely to go up. If you're looking to buy a new house, that five year mortgage rate it's going to be higher. Because what happens is that banks and lenders, they price that mortgage rate off that off Canadian bond yields. So that's where the cost of funds comes in. So when the Bank of Canada says they're going to hike rates, that feeds through to all kinds of borrowing for Canadians.
- And of course, we're going to move from the bond markets to the currency market. And just after the announcement we saw the Canadian dollar surge. Where do you see that loonie going in the next little while?
- Yeah so the loonie is really benefiting from two factors. One is that the fact that the Bank of Canada is likely going to raise rates significantly. At the same time, the Federal Reserve is sitting there being very patient. The Federal Reserve is the central bank to the world. So when they hike interest rates or they get more hawkish like the Bank of Canada is doing today, that feeds through to rates all around the world. So they need to be a little bit more patient. So with the Bank of Canada moving ahead of the Fed and bond markets reflecting that, that means international investors flood into Canadian bond markets to capture that extra yield.
Now, at the same time, energy markets are increasing significantly. We're seeing oil prices, WTI is up above $80 a barrel. We're seeing it through a number of a host of other energy commodities. Natural gas, for example. And all of these are beneficial to Canadian exports, right? And with Canadian exports surging that means that also pushes up the Canadian dollar. So the Canadian dollar has benefited from all of these factors going in the same direction. The question for people trading the currencies, how much further can we go? Is oil going to go towards $100? Or is it going to come back down to more manageable levels? Is Tiff Macklem going to walk away from a little bit of this hawkishness coming from the Bank of Canada?
Is the Bank of Canada really going to be able to hike interest rates significantly in front of the Federal Reserve? How much can they really hike ahead of the Federal Reserve? So all these questions are ones that people trading the Canadian dollar are really going to ask. In our view, it's going to be hard for the Bank of Canada to hike rates significantly ahead of the Fed. It's going to be hard for energy markets to continue to increase significantly towards $100 a barrel. And so as a result, the Canadian dollar is kind of in the sweet spot right now around $0.80.
- OK, so let's talk about some of the implications going forward. You touched on the real estate market. Why don't you start there? What are the implications for housing going forward?
- Well so the implications for housing is that we saw exactly what happened during the pandemic. Mortgage rates dropped, housing prices skyrocketed. OK. Now we're seeing the opposite is happening where mortgage rates are likely to increase over the next few months. They've already started increasing a little bit right now. And hopefully, you know, and this is part of the Bank of Canada's strategy most likely is that there's this macroprudential factor going on. The Bank of Canada doesn't want house prices to go up double digits like it did last year. It doesn't want that because what that does is it makes the Canadian economy really vulnerable to a downturn.
And so by pushing up rates through its communication, it's trying to make sure that housing doesn't accelerate, especially as we pass through the winter time period and into early 2022. And we always have that big surge in house prices. We have a lot of seasonality in Canada. So I think this is going to be a little bit of a headwind for housing. But overall when it comes to house prices and consistency of house price appreciation, we have this thing in Canada where we just don't have enough supply. Demand based on family formations based on immigration has consistently surpassed supply in Canada. And that's not changing.
So we always had this housing demand supply imbalance. And so that's why even though mortgage rates go up, you're not going to have some sort of housing correction in Canada.
- And what about the implications for the labor market? Are there any risks there in the near term?
- Yeah, absolutely. So I mentioned earlier that the most recent employment report showed a blowout level of employment gains in Canada. It was spectacular. We've actually gotten to pre-pandemic levels of employment in Canada. Whereas in the US, they're still way beyond getting to those pre-pandemic levels of employment.
The issue is, and the Bank of Canada's mentioned this too, is it's not equal. We know there's a lot of industries that are still suffering and a lot of people that are looking for a jobs. A lot of people that are in the labor force. They're looking but their businesses that they're associated with are not doing as well as if they wanted to. So there's a lot of inequality in labor markets.
The Bank of Canada, however, is hoping that as things open up, as vaccinations are clearly working to be able to allow us to open up the economy, as we get back in closer and closer to normal, all those jobs hopefully will come back. And they're really hoping that acceleration that we saw last month and employment is going to continue.
And so we're looking at a labor market that is heating up. And I think that's what they're hoping for because there is a lot of disparity based on the industry that people are working in.
- James, thank you very much for joining us.
- Thank you.
[MUSIC PLAYING]
