Bank of Canada Preview: Sitting on the sidelines amid looming recession risks

The Bank of Canada (BoC) is widely expected to stand pat on its interest rates decision this Wednesday at 14:00 GMT. The Canadian central bank is likely to leave the overnight target rate unchanged at 4.50% for the second straight meeting in April.

Economists expect a steady policy from the BoC when it concludes its monetary policy meeting on April 12. Additionally, a majority of forecasters see the rates unchanged for the rest of 2023. Only a small minority predict at least one 25 basis points (bps) rate cut by the end of this year.

Wednesday’s Bank of Canada rate decision will include the Bank’s latest Monetary Policy Report (MPR), with all eyes on the updated second-quarter economic projections. Further, Governor Tiff Macklem’s press conference at 15:00 GMT will also garner a lot of eyeballs, as markets await fresh cues on the future policy course.

All eyes on BoC’s projections and Macklem’s presser

Back in January, the BoC was the first major central bank to halt its tightening cycle and adopt what it calls a conditional pause. The Bank noted that no further tightening would be needed if the economy slows, or even moves into a slight recession. Since then, Canada’s economic performance has somewhat improved, withstanding the global banking sector turmoil.

BoC Deputy Governor Toni Gravelle said last week, the Canadian banking system had a well-earned international reputation for stability, suggesting policymakers are more focused on inflation and how the economy is performing.

After contracting slightly in December, real Gross Domestic Product grew by 0.5% in January. Statistics Canada’s preliminary estimate suggests the economy grew again in February by 0.3%. The Canadian labor market also outperformed, indicating that the economy added way more jobs than forecast in March at 35k vs. 10.2k expected. Moreover, the unemployment rate held steady at 5.0%.

Further, the BoC’s view to stay on hold this month is backed by cooling inflation. The country’s annual Consumer Price Index (CPI) rate fell to 5.2% in February, marking the second month in a row inflation came in lower than forecast, as supply chains recover and commodity prices moderate. It’s worth noting that the monthly data shows inflation is actually closing on the Bank’s inflation target of 2%.

In its previous MPR, the Bank said it expected inflation to average 3.6% in 2023, which was revised down from 4.1% in its previous forecast. It also expected GDP growth of 1.0% in 2023, rising to 1.8% in 2024.

The BoC will remain cautiously optimistic about its growth outlook, as the effect of higher interest rates, which can take up to two years to be fully felt in the economy, is expected to continue broadening out in the economy and hamper growth.           

In its quarterly Business Outlook Survey published on Monday, the BoC said that half of the polled Canadian companies expect the economy to tip into a mild recession over the next year, citing “businesses link expectations of weaker sales growth to rate hikes, high inflation and concern over a recession.”

Despite looming recession risks, Governor Macklem could leave doors open for further rate hikes, conditional on upside risks to inflation. A recent expansionary federal budget and the latest surge in oil prices could ramp up inflationary pressure.

To conclude

Wednesday is expected to trigger extreme volatility for the USD/CAD pair, as investors gear up for the critical United States Consumer Price Index (CPI) and the Bank of Canada’s policy announcements. The US inflation data is likely to help determine the US Federal Reserve’s (Fed) next policy step. Good Friday’s strong US labor market data pushed up odds for a 25 bps May Fed rate hike to 71% vs. 52% ahead of the data release.

Therefore, the US Dollar reaction to the US CPI data and prevailing risk sentiment could influence the impact of the BoC policy outcome on the USD/CAD pair. Hawkish rhetoric maintained by BoC Governor Macklem could temporarily lift the Canadian Dollar but downward revisions to growth and inflation forecasts could continue pushing for a steady policy by the Bank, capping any upside attempts in the local currency.