Bank of Canada lifts rates by 50 basis points again. Is an even steeper increase in the cards?

On the latest edition of Market Week in Review, Director of Investment Strategies, Shailesh Kshatriya, and Director of Institutional Investment Solutions, Greg Coffey, discussed the recent PMI (purchasing managers’ index) readings from China and the U.S. They also chatted about the latest interest-rate increase from the Bank of Canada (BoC), as well as skyrocketing inflation in the eurozone.

China PMI survey indicates slower pace of contraction

Kshatriya opened the conversation with a look at the state of U.S. manufacturing, noting that the latest manufacturing PMI reading from the Institute for Supply Management (ISM) rose to 56.1 in May - up from 55.4 in April and slightly above consensus estimates. A reading above 50 indicates an expansion in business activity, while a reading below 50 points to a contraction in business activity, he explained.

"The latest number suggests that the growth outlook for the U.S. economy remains decent," Kshatriya remarked. He added that weekly initial jobless claims in the U.S. for the week ending 28 May fell to 200,000 from 211,000 the prior week, indicating that the labour market remains tight.

Turning to China, Kshatriya said there’s been a few recent positive developments for the world’s second-largest economy, which has struggled this year due to its zero-COVID approach and associated lockdowns in major cities. The National Bureau of Statistics’ manufacturing PMI reading increased to 49.6 in May, up from a level of 47.4 in April, which suggests that the pace of contraction in China is slowing, he remarked. In addition, Chinese policymakers recently announced several measures to boost the nation’s economy, including tax rebates, subsidies to encourage consumption and, most significantly, additional spending that targets infrastructure, Kshatriya said.

"Overall, based on data from our research providers, this additional package, when combined with previously announced stimulus measures, amounts to about 1.5% of China’s GDP (gross domestic product). So, while government stimulus is still rather measured in scope at this point, we are seeing an incremental loosening in policy to promote growth," he concluded.

BoC lifts rates by 50 bps again, strikes hawkish tone in policy statement

Coffey and Kshatriya shifted their discussion to Canada, with Coffey noting that on 1 June, the BoC increased its policy rate by 50 basis points (bps) for the second time in a row, taking the overnight rate to 1.5%. The hike was in line with expectations, Kshatriya said, adding that what attracted the most attention was a new line in the policy statement accompanying the move, wherein the bank noted it was prepared to act more forcefully - if necessary - in order to bring inflation back to its 2% target.

This hawkish signal from Canada’s central bank was further cemented by Deputy Governor Paul Beaudry, who stated in a 2 June speech that the cash rate may need to rise to the upper end of the neutral range, or even higher, in order to balance demand with supply. "Essentially, this means that hiking rates above 3% is now within the scope of possible BoC outcomes," Kshatriya stated.

He said that the recent hawkish rhetoric has led some individuals to believe that a 75-bps rate increase at the next BoC meeting in July may now be under consideration. "At Russell Investments, we think raising rates by that much in just one shot would be an extremely aggressive move, but the central bank is demonstrating its willingness to act aggressively," he noted. Kshatriya said that an increase of 50 bps at the July meeting would probably be less disruptive.

He added that one factor keeping him cautious on the path of future rate hikes is Canada’s richly valued housing market, which is showing signs of meaningful deceleration. "I suspect that housing fundamentals will likely become front and centre as officials weigh the pace and magnitude of rate raises moving forward," Kshatriya stated.

Inflation reaches new high in eurozone as EU announces partial ban on Russian oil

Shifting to the eurozone, Kshatriya noted that inflation hit a new record high in May of 8.1% on a year-over-year basis - up from the previous record of 7.4% established in April. Core inflation, which strips out prices from the often-volatile food and energy sectors, also increased, he said, rising to 3.8% in May from 3.5% the prior month.

"Both headline and core inflation came in above consensus expectations," Kshatriya remarked, noting that skyrocketing energy prices in Europe - due to the war in Ukraine - were a major contributor to the headline number. However, the rise in core inflation shows that pricing pressures are broadening out across the entire region, he said.

Kshatriya noted that the broader inflation and growth outlook for the eurozone has become further complicated by the European Union (EU)’s 31 May announcement that it plans to ban Russian oil arriving on ships by the end of the year. Notably, oil imports arriving via pipelines will be excluded from the embargo, he said, in order to appease landlocked countries such as Hungary, which rely heavily on Russian oil.

"Importantly, the ban doesn’t take place overnight, so there will be some time for eurozone countries to adjust," Kshatriya said, "but it’s quite clear that the path forward for Europe is becoming increasingly complicated by the war in Ukraine and its impacts on inflation and growth."

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Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice