Breaking: BoC hikes interest rates by 50 bps to 1.00% as expected, to start QT from 25 April

FXStreet Team FXStreet

The Bank of Canada announced on Wednesday that it had increased benchmark interest rates by 50 bps to 1.00% from 0.50%, as widely expected by analysts. The central bank also announced plans to begin reducing the size of its balance sheet, also known as Quantitative Tightening (QT), from 25 April, given that it sees an increasing risk that expectations of elevated inflation could become entrenched. Interest rates will need to rise further and higher rates should moderate growth in domestic demand, the bank noted.

Additional Takeaways as summarised by Reuters:

BoC will use monetary policy tools to return inflation to target and keep inflation expectations well-anchored.
The BoC will end reinvestment in Canadian government bonds - maturing bonds will no longer be replaced and the balance sheet will thus decline over time.
QT will complement increases in the policy rate, which is the bank's primary monetary policy instrument.
The housing market in Canada, which has been exceptionally high, is expected to moderate.
The Russian invasion of Ukraine is causing new economic uncertainty, such as commodity price spikes and price disruptions and these are the main drivers for higher inflation forecast.

Economic forecasts and commentary in the new MPR

The BoC hiked the outlook for Canadian inflation, which is now expected to average just below 6% through H1 2022, above the forecast in the January Monetary Policy Report (MPR), when the bank said it would be close to 5% in H1 2022.
Inflation will remain well above the 1-3% control range until the end of 2022 and will steadily decline to around 2.5% in H2 2023 and 2% in 2024, the bank forecast.
The Canadian economy is moving into excess demand, labor market conditions are tight and the economy is starting to operate beyond its productive capacity.
The BoC said it is paying attention to how inflation expectations are evolving and noted that long-term inflation expecations remain anchored on target, while near-term expectations have risen.
The effects of the Ukraine war to add 0.7% to CPI in 2022
Overall, 2022 inflation is seen at 5.3% (vs previous estimate of 4.2%), 2023 inflation is seen at 2.8% (vs previous estimate of 2.3%) and 2024 inflation is seen at 2.1%.
Risks to the inflation outlook are roughly balanced but upside risks are of greater concern because inflation is very high.
The BoC projects 2021 Canada GDP growth was 4.6%, 2022 GDP growth is seen at 4.2% (vs previous estimate of 4.0%), 2023 GDP growth is seen at 3.2% (vs previous estimate of 3.5%) and 2024 GDP growth is seen at 2.2%.
The output gap in Q1 was between -0.25% and +0.75%, higher than the Q4 estimate of -0.75% to +0.25%.
Potential output growth is assumed to average about 2% a year over 2022-2024 vs the January forecast of 1.6% a year over 2021-2023.
Total ownership of Canadian government bonds outstanding has dipped to 43% from 45% in January, while the value of total assets in Canadian government bonds has remained constant at C$430B.
The BoC has updated its estimated range of nominal neutral interest rate to 2%-3%, 0.25% higher than in the April 2021 reassessment.

Market Reaction

The loonie saw a choppy reaction to the latest BoC policy announcement and MPR and currently trades a tad lower versus pre-announcement levels in the 1.2640s, where it is now flat on the day.

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