Bank of Canada announces pause in rate hikes
On the latest edition of Market Week in Review, Investment Strategy Analyst BeiChen Lin and Sophie Antal-Gilbert, Head of AIS Portfolio & Business Consulting, discussed the fourth-quarter U.S. GDP (gross domestic product) numbers as well as recently released PMI (purchasing managers’ index) surveys from around the globe. They also chatted about the latest developments from the Bank of Canada, including the announcement of a pause in rate increases.
U.S. economy grows 2.9% in final quarter of 2022
Antal-Gilbert and Lin kicked off the conversation with a look at the U.S. GDP reading from the fourth quarter of 2022, which Lin characterized as relatively strong. “Last quarter, U.S. GDP grew at a rate of about 2.9% on an annualized basis,” he stated, adding that for the entire year of 2022, GDP rose at a 2.0% clip on an annualized basis. The solid economic growth reading stands out as one of the few bright spots in an otherwise very challenging year for investors, Lin remarked, noting that both U.S. equities and bonds were down significantly in 2022.
He said that the 2023 growth outlook for the U.S. appears less optimistic, especially with recent leading economic indicators showing more signs of softness. “Amid this backdrop, I think that the probability of a mild recession striking the U.S. this year is still relatively elevated,” Lin remarked.
What do the latest PMI surveys indicate about global growth?
Zoning in more on recently released economic data, Lin said flash January PMI numbers for both the U.S. and the UK indicated contractionary conditions in the manufacturing and services sectors. The eurozone composite PMI, on the other hand, did manage to return to expansionary levels in January, he said, rising to a level of 50.2. A reading above 50 indicates expansionary conditions, and a reading below 50 indicates contractionary conditions, Lin explained.
“The bottom line here is that the latest PMI numbers are pointing to a likely economic slowdown in the U.S. and many other developed markets,” he stated, adding that this isn’t too surprising, due to the series of aggressive interest-rate hikes implemented by global central banks last year. “Rate increases lead to slowdowns in economic activity—and that’s exactly what we’re seeing,” Lin remarked.
Bank of Canada raises policy rate to 4.5%, signals likely pause
Expanding further on the topic of rate increases, Lin noted that the Bank of Canada (BoC) lifted borrowing costs by 25 basis points at its Jan. 25 meeting, taking the overnight rate to 4.5%. The move is the latest in a series of rate hikes undertaken by Canada's central bank over the past 10 months, he said—and more notably, it could be the last rate increase for a while. This is because the BoC also announced it is pausing its rate-hiking campaign for the time being, in order to assess the effects of higher interest rates on the Canadian economy, Lin said.
“It’s important to understand that monetary policy works with a lag—so it can take some time for the full impacts of a tightening cycle to become clear,” he explained. Lin added that even with the BoC on pause, Canada’s economy will still continue to slow, because at 4.5%, borrowing costs are well above the so-called neutral rate. Lin explained that this rate, which he estimates to be around 2.5%, is the level at which monetary policy neither restricts nor stimulates economic growth.
Importantly, however, BoC Governor Tiff Macklem emphasized that the pause in rate hikes is a conditional pause, Lin noted. “This means that if future inflation numbers don’t play out as expected, it’s possible the bank may have to raise rates even further to bring inflation back to its 2% target,” he explained.
Ultimately, the BoC and other key central banks around the world are committed to taming inflation, and will do whatever it takes to bring price pressures under control, Lin said—even if that means causing some softness in the economy. “This is one of the reasons why I think it’s possible there could a mild recession this year,” he concluded.