All eyes on the Bank of Canada’s decision and what a “hawkish hold” might suggest

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Written on Jun 5, 2023
Reading time 3 minutes
  • This week's Bank of Canada decision looms large
  • A hawkish hold might suggest a June skip from the Fed
  • Volatility is set to increase

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The week ahead is a tricky one for those involved in financial markets. Positioning is crucial because it is the week that precedes the Federal Reserve and the European Central Bank decisions.

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Therefore, the name of the game this week is to look for clues. And to find them.

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One clue might surface as early as Wednesday. The Bank of Canada is due to announce its monetary policy, and the market expects it to leave the policy rate at 4.5%.

This is one central bank not shy of surprising markets with its decisions. For this week’s decision, there is a 25% chance of a hike, but the implications of what the central bank does go beyond Canada’s borders.

US and Canadian inflation rates are tightly correlated

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A quick look at the historical inflation rates in Canada and the United States reveals that the two are tightly correlated. Hence, given their price stability mandate, the two central banks’ policies should be correlated too.

After all, this is what the Bank of Canada did with the policy rate in light of rising inflation. The Fed did the same.

Only now, rumors in the market suggest that the Fed may “skip” a June interest rate hike. Sure enough, time will tell, but until then, the Bank of Canada might offer traders some hints.

The central bank has all the reasons to hike. For example, GDP and labor data remain robust. Also, inflation is well above the level it should be.

Therefore, a hold might be considered hawkish if conditioned by future inflation rate levels. It may hint that the Fed might do just the same one week later.  

Is a hawkish hold suggesting a June “skip” from the Fed?

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Central banks’ terminology is often difficult to interpret. If the Bank of Canada does not hike, the market will believe that the Fed will do the same.

But the trick is how to communicate to markets that, as a central bank, you remain hawkish, despite holding the interest rate steady.

It may be too early to tell what the Fed will do next week, but the Bank of Canada will clearly offer some clues. A “hawkish hold” on Wednesday suggests a “skip” from the Fed one week later, and that, in turn, will move financial markets.

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