Traders increasingly doubt Bank of Canada's rate-hike timeline

Traders are betting that the Bank of Canada will be forced into raising interest rates earlier than expected, posing one of the stiffest tests yet for Governor Tiff Macklem.

Traders are betting that the Bank of Canada will be forced into raising interest rates earlier than expected, posing one of the stiffest tests yet for Governor Tiff Macklem.

Bets in the overnight swaps market are increasingly tilting toward a move early next year, well ahead of the U.S. Federal Reserve. Traders have now priced in three hikes in Canada by the end of 2022, which would bring the policy rate to 1 per cent from the current 0.25 per cent.

That’s about 50 basis points higher than markets were expecting just a month ago. The shift in pricing is increasingly at odds with Macklem’s guidance that borrowing costs won’t increase until slack is absorbed and inflation returns sustainably to its target range. 

The bank has said repeatedly it doesn’t see that happening until the second half of next year.

Analysts are warning that the uncertainty surrounding liftoff in Canada could undermine the effectiveness of the bank’s forward guidance.

“If Macklem capitulates around an early rate hike when he thinks spare capacity might still exist then the whole exit framework will turn into a dumpster fire,” Derek Holt, an economist at Bank of Nova Scotia in Toronto, said by email. “It could make forward guidance a very weak tool in future and magnify risks to policy efficacy.”