Fergal Smith

TORONTO (Reuters), The Bank of Canada could cut short current economic growth if its attention shifts from reducing slack to tamping inflation. This may set the stage for the next round of rate cuts.

This is a problem for the central bank because inflation can be driven by many factors other than economic strength. If inflation expectations rise, this could cause more lasting price increases.

The BoC announced last month that it would be the first G7 central bank to end quantitative easing. It also indicated that it might begin raising interest rates in April. This is three months earlier than originally thought.

James Athey from Aberdeen Standard Investments, London said that investors believe the BoC should raise its rates several times in order to combat inflation. Inflation is supply-side driven, cost-pushy and temporary. Therefore hikes will be made at a time when there’s falling growth.

An economic cycle can last for as little as one year or as long as 10 years. Following the 2008 global financial crisis, which ended in 2009 with the onset of the COVID-19 epidemic last year, saw the previous expansion.

Although the BoC was originally going to make activity hotter in this cycle to help boost employment and more than previous recoveries, it has now shifted its attention to pushing inflation closer to its goal of 2% according to analysts.

September’s inflation was 4.4%, the highest reading in more than two decades.

The Federal Reserve is expecting a rate hike in March, and five more next year. This would be a significant increase for the money markets. Economy activity tends to be slowed by tightening periods.

Markets expect economic growth slowing because of the yield curve. Since the last policy change, Canada’s gap between its 2-year and 10-year yields have fallen from 130 basis point in favour of longer-dated bonds (March) to 54 basis points.

Investors expect a higher yield on longer-term bonds than they are used to, even if rates will fall. A recession warning would include a negative spread (or curve inversion).

Ian Pollick from CIBC Capital Markets, Global Head FICC Strategy at CIBC Capital Markets stated: “The repricing on the front-end has rendered the curve into the coming hiking cycle flatter that it has ever been”

The curve may prematurely invert, which increases its risk.

Canadians could boost recovery by spending their large cash hoardings, which they have amassed during the pandemic.

Inflation is impacting consumer confidence. It could also be more sensitive than just few years ago to price increases, as households have increased borrowing in order to get into a hot housing market.

Robert Robis (Centre for Global Fixed Income Strategy at BCA Research) stated that “the market is a bit pessimistic” right now. The market is betting “any rate increase cycle” will not last long and could be reversed quickly.