Top 3 reasons why the Bank of Canada will “out hike” the Fed

The first trading day of the new month begins with the Bank of Canada announcing the monetary policy. It was one of the first central banks to remove the stimulus from the economy in the aftermath of the COVID-19 lockdowns, and now it is set to raise the overnight rate even more.

In Canada, the interest rate is already at 1%, but today the market expects another 50bp rate hike. Moreover, some market participants believe that the Bank of Canada may even deliver a 75bp rate hike today due to inflation being much higher than the bank’s target.

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So here are three reasons why the Bank of Canada is more hawkish than the Fed and, in the long run, why it will “out hike” the Federal Reserve:

• Canada’s job market outperforms the one in the United States
• A hawkish surprise should not be discounted
• More rate hikes to come

Strong domestic job market

In Canada, the job market has fully recovered all the jobs it lost during the pandemic – and some more. Furthermore, job vacancies exceed one million, so the pressure on the wages to rise intensifies.

But higher wages bring higher inflation, and inflation is already well above the central bank’s target. As such, the strong domestic job market is only another reason for the Bank of Canada to be more hawkish and, perhaps, deliver a bigger rate hike than the market expects.

Markets should not discount a hawkish surprise

It would not be the first time that the Bank of Canada has taken market participants by surprise. This is a central bank known for not being shy when it comes to surprising markets, as, in the past, it often did something else than it was priced in.

Hence, we might see a 75bp rate hike today especially considering that the 1% interest rate is well below the 5.1% inflation rate in April.

More rate hikes to come

The central bank has said that even at 1%, the interest rate is too stimulative. Combined with the growth rate, the interest rate should exceed the inflation rate – it doesn’t.

Hence, as long as the interest and growth rates are below, conditions are viewed as stimulative. Therefore, more rate hikes are in the store in the months ahead.

How about the USD/CAD exchange rate?

The USD/CAD exchange rate topped at 1.30 this year and still looks for direction. 1.24 is a critical level, and a close below opens the gates to a move to 1.20.