Scotiabank said it is doubling down on its forecast for the Bank of Canada to begin tightening monetary policy over the second half of the year, citing rising inflation risks and stronger economic drivers.
From 2.25% at present, the bank said it thinks the policy rate will rise to 3% by year-end.
Scotiabank Economics has forecast hikes by the end of 2026 since last November. One more was added in March in response to supply chain and commodity shocks related to the war with Iran.
"The BoC just opened the door wider to a rate change." It said "... if the economy evolves broadly in line with the base case, changes in the policy rate can be expected to be small." But in which direction?" the bank said in its latest foreign exchange outlook.
"A rate cut scenario that hinged upon higher US tariffs against Canada was presented. It lacks credibility in our view. One reason is that it would prompt excessive easing of financial conditions. With markets priced for 50-75bps of hikes this year, a 25bp cut would strike that out, add the cut, probably price 1-2 more, and result in short-term market rates plunging by 100bps or more," said Derek Holt, Head of Capital Markets Economics.
The effect would tank the Canadian dollar, driving more import price pressures, said Holt adding that the bank remains "cautiously optimistic" toward trade negotiations.
"A hike scenario was also presented by the BoC and conditioned on higher-for-longer energy prices. Yet it's not just energy prices as evidenced by the BoC's own measure. Canada is importing higher incomes through higher prices for many of the products it sells with trickle down effects into domestic incomes and more resulting spending. Smaller deficits driving increased federal spending represent one such example equal to 1/2% of NGDP this year and 1/4% next year; the BoC's communications did not have time to incorporate this added fiscal stimulus that further merits higher rates. Inflation risk has pivoted higher," noted Holt.