Fergal Smith

TORONTO, (Reuters) – Canada’s rising inflation and recovering employment market have put pressure on Bank of Canada. This week investors will look for clues from the Bank to see if they are increasing interest rates sooner than planned.

Tiff Macklem (BoC Governor) is scheduled to increase the BoC’s inflation forecast on Wednesday. He will also end its stimulus program from pandemic-era bonds buying programs. It will begin a countdown towards the first interest rate rise since October 2018.

According to its most recent forecasts, the central bank will keep interest rates at record lows of 0.25% for as long as economic lack is abated. It has always maintained that inflation-causing factors are temporary.

Money markets, however, see a divergent path. They anticipate pricing the first rate hike in April, and close to 100 basis points total tightening next year. This is up from 35 base points in September. Rates will rise in large economies sooner than investors expect.

There is growing concern that the Bank of England will be forced to lower rates by inflation and could become the first central bank to do so in November. However, there are increasing signs that the U.S. Federal Reserve may feel more pressure to tighten policies sooner than expected and perhaps even aggressively.

Karl Schamotta from Cambridge Global Payment, chief market strategist said that “markets are playing chicken worldwide with central bankers. They bet that policymakers will follow Bank of England and capitulate to higher-than-expected inflation rates.”

Canadian inflation has been above the BoC target range of 1%-to-3% for six consecutive months. It climbed to 4.4% in September, an 18-year-high, and has recovered all jobs lost during the pandemic.

Analysts believe that, if the BoC decides to increase its interest rate before the end of the year’s second quarter, it will likely change its guidance ahead of time. The bank also stated that investors would be able to trust its forecast and not expect to see any deviations from the outlook, fearing market volatility.

Recent days have seen the Canadian dollar rise to near 1.23 per greenback (81.30 U.S.cs). The gap between Canadian 2-year yields and those of America has increased to 41 basis points to the Canadian bond.

Schamotta stated that investors are convinced that Bank of Canada will fight inflation. This assumes that the economy is strong enough to absorb any slack, even though monetary conditions become less accommodating.

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Canadian buyers could see rate rises happening at a quicker pace than expected after they took out variable-rate mortgages this year in record numbers.

There is an example. There is a precedent. In 2010, after the recovery of the global financial crisis ended, Mark Carney, the BoC governor, abandoned his conditional promise to hold rates steady and instead raised them sooner than anticipated.

“If your last breached your promise, this might make it reasonable for markets that they price in more, not fewer, rate rises next year than what the Bank of Canada is telling us right now,” said Royce Mendes senior economist, CIBC Capital Markets.

Investors are still placing bets on the economy, despite uneven growth and a surprising contraction in the second-quarter.

ForexLive chief currency analyst Adam Button said that central banks are currently being bullied and manipulated by the markets. “The Bank of Canada needs to recognize a change in market expectations and push back harder at some point.”