The global tightening cycle is in full swing, with half-point interest rate hikes from the Bank of Canada and the Reserve Bank of New Zealand. Expectations for changes by both central banks did not stop the Canadian and New Zealand dollars from reacting strongly to these adjustments. The Canadian dollar soared after the rate decision, while the New Zealand dollar plunged. Their diametrically opposite movements underscores the importance of policy guidance.
To the surprise of many investors, including ourselves, the Canadian dollar sold off ahead of the rate decision, hitting a bottom about an hour before the Bank of Canada raised interest rates by 50bp for the first time in 22 years. This was the bank’s largest single move in more than two decades.
According to Governor Tiff Macklem:
“The economy can handle higher interest rates, and they are needed.”
Like many countries around the world, Canada is struggling with high inflation – the last consumer price report from February showed prices growing at its fastest rate in 30 years. Russia’s invasion of Ukraine drove prices even higher in March. Although a half-point hike and the end to bond purchases were widely anticipated, Macklem’s guidance sent the loonie soaring.
He said: “We are prepared to move as forcefully as needed to get inflation on target," adding that rates should return to the “neutral range of 2% and 3%.”
Canada should brace for another 100 to 200bp of tightening this year.
The New Zealand dollar plunged despite a similar-size rate hike from the Reserve Bank. The half-point move from the RBNZ was a surprise, as economists had been looking for a quarter-point hike. However, according to the RBNZ, “The committee agreed that their policy ‘path of least regret’ is to increase the OCR by more now, rather than later, to head off rising inflation expectations.”
Even though the RBNZ said “it is appropriate to continue to tighten monetary conditions at pace,” investors interpreted today’s move as a dovish hike and a sign of the central bank slowing down. It has raised interest rates for four straight meetings since October as inflation surged to 5.9%.
Tomorrow, the focus turns to the European Central Bank, which is not expected to change monetary policy. Although high inflation is also a problem in the Eurozone, growth is hampered by sanctions on Russia, supply-chain issues and the shock of higher food and energy costs on consumers. The rise in long-term rates across Europe should help to cool prices. Even if the ECB can’t raise rates this week, there are steps that can be taken in that direction. The most important of which is addressing its Quantitative Easing program. Previously, the ECB said rates won’t increase until asset purchases end. The choice now is to end QE immediately or to shift guidance by suggesting that rates could increase as QE is unwound. We expect the ECB to raise interest rates this year, but the move may not happen until the late third or early fourth quarter, leaving the central bank far behind its peers.
The U.S. dollar is trading strongly, particularly against the Japanese Yen ahead of Thursday’s retail sales report. With prices and wages rising, consumer spending growth is expected to accelerate. The focus will be on core prices – if spending ex-autos and gas beats, USD/JPY could extend its gains. Even if it doesn’t, expectations for a half-point hike at the next FOMC meeting will remain intact.
