Canada’s central bank says the economy needs to slow from overheated levels to dampen inflation. If its tightening campaign exceeds this target, it could trigger a deeper recession than expected.
The bond market could signal this risk. The yield on Canada’s 10-year government bond has fallen nearly 100 basis points below the 2-year yield, marking Canada’s largest yield curve inversion in Refinitiv data dating back to 1994 and deeper. than the inversion of the US Treasury yield curve.
Some analysts view curve inversions as predictors of recessions. The Canadian economy is likely to be particularly sensitive to a rate hike after Canadians borrowed heavily during the COVID-19 pandemic to participate in a booming real estate market.
“Markets believe the Canadian economy is about to take a triple hit with collapsing domestic consumption, weakening US demand and falling global commodity prices,” Karl Schamotta said. Chief Markets Strategist at Corpay.
The BoC opened the door to slowing the pace of rate hikes to a quarter of a percentage point after multiple oversized hikes in recent months that took the benchmark rate to 3.75%, its highest level since 2008.
Currency markets are betting on a 25 basis point rise when the bank meets to set policy on Wednesday, but a slim majority of economists polled by Archyde.com expect a bigger move.
A RESILIENT ECONOMY
The employment report
job report
for November showed that the labor market remains tight, while the
gross domestic product
increased at an annualized rate of 2.9% in the third quarter.
This rate is much higher than the 1.5% rate forecast by the Bank of Canada and, together with upward revisions to historical growth, could indicate that demand has exceeded supply, economists say.
But they also say detailed third-quarter GDP data, including a contraction in domestic demand, and a preliminary report indicating zero growth in October are signs that higher borrowing costs have started to have an impact. on the activity.
The BoC has forecast growth to stagnate from the fourth quarter of this year until the middle of 2023.
The depth of Canada’s curve inversion signals a “bad recession” and not a mild recession, said David Rosenberg, chief economist and strategist at Rosenberg Research.
It reflects greater risk to the outlook in Canada than in the United States due to “a more inflated residential housing market and a consumer debt bubble,” Rosenberg said.
Inflation is likely to be more persistent after spreading from the prices of goods to services and wages, where higher costs may become more entrenched. However, the three-month core inflation measures closely watched by the BoC – CPI-median and CPI-trim – show that price pressures are easing.
They fell an average of 2.75% in October, according to estimates by Stephen Brown, senior economist for Canada at Capital Economics. This is well below the more commonly used 12 month rates.
“The yield curve would not invert at this point unless investors also believe inflation will come back down towards the Bank’s target,” Brown said.
Like the Federal Reserve, the BoC has an inflation target of 2%.
“The curve tells us that the Bank of Canada will be forced into a reversal by the end of 2023, with rates remaining depressed for years to come,” Corpay’s Schamotta said. (Reporting by Fergal Smith; editing by Andrea Ricci)