Michael Watkins
July 14, 2023
Weekly Market Update
Well it’s been a much more positive week this week, as markets turned more enthusiastic after better than expected CPI numbers came out in the States.
The Bank of Canada (BoC) raised its benchmark overnight interest rate by 25 basis points (bps) at a second consecutive meeting. At its March and April meetings, the BoC paused interest-rate hikes on the expectation that economic growth would slow and inflation might fall relatively faster. But stronger-than-expected growth in the first quarter and persistent inflationary pressures have put the BoC back on a path of tightening monetary policy.
- The BoC raised its benchmark overnight interest rate by 25 bps to 5.00%, its highest rate since 2001. The second straight increase was widely expected by economists, based on a survey by Bloomberg.
- Canada’s central bank cited strong economic conditions that have kept inflationary pressures at high levels, warranting this rate increase. A strong labour market has helped keep consumer spending relatively robust, adding to inflationary pressures. The BoC hopes this additional stimulus might help cool economic activity and drive down inflation.
- The BoC revised its inflation expectations at this meeting, believing inflation will linger around 3% over the next year before declining to its 2% target by mid-2025.
- The 25-bps hike pushes Canada’s key interest rate closer to the federal funds rate in the U.S. However, the U.S. Federal Reserve Board (Fed) will likely proceed with another rate increase at its next meeting after yesterday’s report that inflation was 3.0% year-over-year in June. Despite inflation moderating and coming in below expectations, it remains too high for the Fed
The BoC did not give clear direction on whether more rate hikes are likely, but it did note it would continue to monitor economic data and remains committed to its goal of price stability. Interest rates are poised to be higher for longer, which might boost earnings on savings accounts and bonds but also raise borrowing costs. Equity markets could be volatile as expectations adjust to decisions by the BoC and other central banks. But equity markets could get some tailwinds as the BoC and Fed reach what investors expect to be the end of its rate-hiking cycle.
Turning to the States, the U.S. Bureau of Labor Statistics announced that year-over-year producer price growth in the U.S. softened significantly in June. This announcement follows the U.S. inflation report from the previous day showing consumer prices also eased in June. While still relatively high, the easing prices for consumer and producer goods provide some relief for Americans, who have been challenged by ultra-tight conditions
- U.S. producer prices rose by 0.1% year-over-year in June, a significant slowdown from the 0.9% annual increase in May. This increase marks the lowest annual producer price growth since 2020, when prices declined.
- The U.S. inflation rate for June was 3.0% year-over-year, dropping from 4.0% in the previous month and below the 3.1% rate economists expected, based on a survey by Bloomberg.
- Another drop in the U.S. inflation rate provides some welcome relief for U.S. consumers. U.S. consumers have been under enormous pressure from inflation and aggressive rate hikes by the U.S. Federal Reserve Board (Fed). The slowdown was driven by a decline in energy prices and moderating prices for food, shelter and new vehicles.
- The drop in the U.S. inflation print likely did little to deter the Fed from raising interest rates at its next meeting. Fed officials have pointed out that more rate increases are likely this year as it looks to bring inflation closer to its 2% target. However, the sharp drop in inflation might signal that the Fed is closing in on the end of its rate increases.
Easing inflation in the U.S. could result in better economic conditions here in Canada. Should U.S. consumers and businesses pick up spending activity, demand might improve for goods and services produced in Canada, which would help the Canadian economy.
Over in Asia, the People’s Bank of China (PBOC) reported new loans from China’s banks advanced significantly in June. The rise in new loans comes as the PBOC reduced its key interest rates to help support China’s relatively lacklustre economic activity. It was a positive sign that the first rate reduction in almost a year helped increase new loans.
- China’s banks gave out CNY3.05 trillion (C$561.7 billion) in new loans in June, up from CNY1.36 trillion (C$250.5 billion) in May, the second straight monthly increase.
- The increase in new loans comes as the PBOC reduced its key interest rates by 10 basis points at its June fixing. The PBOC decreased its one- and five-year loan prime rates (LPR) to 3.55% and 4.20%, respectively. The one-year LPR is a reference for corporate and household loans, while the five-year is a reference rate for mortgages.
- China’s central bank is hoping these rate reductions will help support the domestic economy. The rise in new loans will likely lead to higher spending by households and businesses, which could help drive growth. China’s economy grew by 4.5% year-over-year in the first quarter, below the government’s 2023 target of 5.0% growth.
- While China is looking to reduce rates amid relatively muted growth and ultra-low inflationary pressures, other central banks are going in the opposite direction. Recently, U.S. Federal Reserve Board officials have commented that rates need to go higher. Central bankers in Europe, the U.K. and Canada share that sentiment.
The PBOC’s recent rate reduction indicates a global economy filled with uncertainty and uneven growth. While some economies, such as Canada, have seen relatively strong growth, growth in the U.S., Europe and China has been somewhat sluggish.
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Source: CIBC Morning Market Brief