Takeaways for advisors after Bank of Canada decision

The Bank of Canada announced its interest rate decision yesterday, holding its key rate steady at 5.00%. While the hold was widely expected by analysts, the commentary following the announcement as well as wider news about the Canadian economy gave some hints as to whether this interest rate hiking cycle is truly done, if there could be a chance of further hikes, or when we may eventually see an interest rate cut.

In the press release announcing its decision, the BoC stated that they view the current interest rate as high enough to remove “excess demand” from the economy. However, they mentioned that if their estimates are off they are willing to hike rates again. Most analysts took that news with a shrug, however, and noted that it’s little more than the central bank ensuring they can hike if unforeseen circumstances force them to. The consensus, instead, seems to have fully shifted towards expectations for a cut in the new year.

“I’ve been saying that the central banks may need to start cutting in the first half of 2024 for a little while now and I still believe that’s true, I don’t think this decision changes anything along those lines,” says Paul Marcogliese, SVP & portfolio manager for fixed income at CI Global Asset Management. “I believe that if they feel the need to cut because it’s what’s right for the Canadian economy, they’ll do just that. I do think they recognize that cutting will be needed, it’s just a matter of getting enough comfort on the inflation side, which in my prediction they’ll get sometime in the first half of 2024.”

Within their inflation commentary, the BoC noted that shelter costs have risen due to higher rents and higher mortgage costs. That is one inflationary impact of the rate hiking cycle, however Marcogliese believes it’s somewhat less of a concern than other inflation drivers. He says that mortgage costs driving inflation will only force the BoC to cut if it is the sole driving force and all other contributors to CPI or core CPI are in line with the Bank’s targets.

Brooke Thackray, research analyst at Horizons ETFs, noted that the BoC is combatting another driver of inflation: government spending. As the Federal Government increases the deficit with more spending programs, that has an inflationary impact on the economy. That could shift the aggregate inflation data and keep inflation higher for longer. Thackray largely agreed, however, that cuts should come in April of next year, but doesn’t think we’re going to get any cuts deep enough to bring rates to COVID levels.

“We’re at this stage right now with rates at 5% and people are looking at this and saying it’s not normal, but if you go back historically speaking that’s not really a high rate,” Thackray says. “We are probably not going to go back down to where we were before.”

Thackray thinks the BoC will pause at its next meeting in January as well, as any eventual decision to cut should come with a much firmer understanding of both inflation and GDP growth. If the BoC cuts prematurely, and inflation rears its head again, that could result in a much more significant problem as switching back into a hiking cycle can be very difficult.

Looking at Canadian equities coming out of the decision, Thackray thinks they’re broadly well-positioned given their somewhat lower valuations. Canada is heavily underweight tech, which is the leading global growth sector in 2023, but he expects there to be some rotation out of tech towards more value-based and commodity names next year, which are better represented on the TSX. Even as global growth slows, there is massive demand for Canadian natural resources and that should have a tailwind impact on the TSX in Thackray’s view.

Marcogliese offers that fixed income now looks more attractive than it has in years. If rates truly have peaked there are opportunities to capture higher yields and potential for significant upside emerging from any rate cuts. As advisors look more closely at the fixed income market, he advocates for due diligence on the range of fixed income products now available, finding the right kind to support client portfolios.

While opportunities will present themselves across different asset classes, both Thackray and Marcogliese agree that when the BoC starts cutting, it doesn’t mean a fast return to 2021. This will be a slow process of change, and one that may never see us return to rates that low again.

“This is a long process. Rates may come down, but it may not be for a while. When they do come down, they’re going to come down slowly unless the economy is in big trouble,” Thackray says. “Rate cuts aren’t going to save the market, investors shouldn’t be relying on that, because this is a long process dealing with a big problem.”