Michael Watkins
January 19, 2024
Weekly Market Update
At its first meeting of 2024, the Bank of Canada (BoC) held its benchmark overnight interest rate steady, which came as no surprise to market participants. The BoC offered a sliver of hope that interest rates might come down this year after pointing to a strong likelihood that interest-rate increases are over. The BoC believes its key interest rate is at restrictive levels, which has helped moderate inflation and economic activity.
- The BoC kept its benchmark overnight interest rate unchanged at 5.00% at its January meeting. Economists surveyed by Bloomberg were expecting the rate hold. January’s meeting was the fourth straight where the BoC held steady.
- The benchmark overnight interest rate stands at its highest level since 2001 after an aggressive campaign by the BoC to lift interest rates in response to decades-high inflation. With inflation moderating and economic growth waning, many are left to wonder when the BoC will start pulling rates back.
- Canada’s central bank was clear that it was done raising interest rates if economic conditions develop as expected. The BoC projects inflation to hover around 3% over the first half of 2024 before slowing to 2% next year.
- BoC Governor Tiff Macklem pointed out that conversations among officials are now shifting to how long they should maintain rates at current, and restrictive, levels. Besides the slowdown in inflation, the BoC sees economic growth waning and the labour market starting to soften. The BoC expects Canada’s economic growth to be relatively muted over the short term.
Given its ongoing concern about inflation, the BoC seems hesitant to lower interest rates just yet. Interest rates appear poised to come down this year, but they will likely remain at relatively elevated levels compared to just a few years ago.
Across the pond, the European Central Bank (ECB) kept its key interest rates unchanged following its January policy meeting. The main refinancing rate remained at 4.5% and the deposit rate stayed at 4.0%. In the statement that accompanied the decision, ECB officials highlighted that “tight financial conditions are dampening demand… helping to push down inflation.” The decision aligned with market expectations.
- Rates are restrictive enough according to ECB policymakers and holding them for long enough should help to bring inflation to its 2% target.
- ECB President Christine Lagarde acknowledged that the euro-area economy likely weakened in the fourth quarter of 2023. Still, there was consensus among officials at the policy meeting that it was too early to consider rate cuts. Market expectations for rate cuts have been partially supported by the decline in inflation from its peak of over 10% in October 2022.
- Inflation climbed to 2.9% in December compared to 2.4% in November. The rise was expected given a smaller decline in year-over-year energy prices in December. The ECB council reiterated its determination to manage inflation.
- ECB officials drew attention to the ongoing decline in underlying inflation. They suggested that the higher cost of capital was helping to stabilize prices by dampening demand. The ECB is also paying attention to potential disruptions to shipping lanes in the Red Sea, which could affect energy and shipping prices.
The cautious stance and attempt to postpone the rate cut discussion reflects the ECB’s need to see the disinflation process continue even further. This way, the central bank says it can be more confident that inflation can remain sustainably at the 2% target.
Looking at the bigger picture, Fitch Ratings predicted major central banks across the world will begin lowering interest rates this year. This is consistent with the expectations of most market observers, who see central banks pivoting to rate cuts in response to moderating inflation and weakening economic growth. The question then becomes how far will policymakers drop rates this year?
- Fitch believes central banks worldwide will begin lowering interest rates in 2024. Nineteen of the 20 economies it reviewed will likely deliver rate cuts this year. The lone exception, according to Fitch, will be the Bank of Japan (BoJ), which is expected to raise interest rates from its current level of −0.10%.
- Given the relatively cautious statements from the US Federal Reserve Board (Fed) at its last meeting, and softening inflationary pressures, the Fed appears to have reached its peak interest rate level. Fitch also believes the Bank of England (BoE) and European Central Bank (ECB) have reached peak levels, which are relatively restrictive.
- Market participants are currently expecting steep rate cuts this year. Fitch is pumping the brakes on those expectations. The ratings agency doesn’t believe rate cuts will be as sharp as markets might expect given inflation is still elevated and the labour market is still relatively robust.
- The BoJ held steady at −0.10% at its announcement on Monday night. On Sunday night, the People’s Bank of China held steady, but markets are hopeful for more policy easing to help support China’s economy. The Bank of Canada makes its first interest-rate announcement of 2024 today, while the ECB meets on Thursday. The Fed and BoE are up next week.
With markets expecting rate cuts in 2024, global equities have risen sharply since November. While rate cuts are widely expected, the pace of those rate cuts is largely unknown. Fitch believes even if interest rates fall, they might still be above pre-pandemic levels. By reducing interest rates, inflation might moderate further and get closer to target levels, easing the financial pressure on households and businesses.
As always, please give us a call if you have any questions, or if you’d like to get together for a portfolio review.
Finally, a big thank you to James and Kelsey for delivering a great presentation on the Power of Financial Planning! Lots of positive feedback from everyone that attended.
Source: CIBC Morning Market Brief