Markets getting ahead of themselves on rate outlook

Financial markets appear to be ignoring the Bank of Canada’s latest warnings about the uncertain economic outlook and are pricing in an interest rate hike before the end of this year. In contrast, we think there are good reasons why monetary policy in Canada is actually headed in the opposite direction to US policy. Although the oil price shock is over, investment remains weak and exports are still misfiring. Meanwhile, with house prices completely detached from household incomes and the Vancouver market already on its knees, housing could become a severe drag on Canada’s economy. Despite the positive GDP and employment data and expectations of rising interest rates in the US, dovish comments by the Bank of Canada’s Governor and Deputy Governor over the past several days suggest that interest rates won’t be going up in Canada anytime soon. Canadian policymakers appear focused on the recent decline in domestic core inflation and the downside risks to the economic outlook, which still includes the threat of US protectionism. Nevertheless, financial markets aren’t buying this dovish talk and expect the Bank of Canada to begin raising interest rates before the end of this year.