Establishing definitive terminal policy rates proves arduous as central banks juxtapose decelerating inflation and lagged repercussions of prior constrictions against varied activity markers and vigorous employment sectors. The BoC emerged as the premier significant central bank to suspend its constriction cycle subsequent to a 25 bp increment in January, while others remain unprepared to withdraw from the limelight. Equity and bond markets experienced a renaissance the previous month as investors' conviction swelled concerning the Fed nearing its constriction cycle finale, although a startlingly robust employment report cast aspersions on that notion. After a series of central bank convocations in early-February, we have amplified our terminal policy rate prognostications for the BoE (+50 bps), ECB (+25 bps), and RBA (+25 bps). We persist in presuming the Fed's forthcoming increment will be its ultimate, though payroll vigor and Fed directives render risks biased toward the ascendant.
As inflation decelerates yet employment markets endure, aspirations for a gentle descent proliferate. Post continual reductions in global growth estimates the previous year, the IMF revised its GDP predictions upward in January, forecasting a 2.9% enhancement this year, approximating the global economy's trend growth rate. Unforeseen economic data potency and diminished energy costs lead us to anticipate a more moderate recession in the UK, and deceleration rather than absolute contraction in the euro area. Nevertheless, we still foresee mild recessions in Canada and the US in 2023, as recent gauges (excluding employment data) demonstrate both economies losing impetus in the latter part of the prior year.
While employment markets continue to simmer, exceeding central banks' tolerance, we conjecture they'll ultimately emulate the BoC's precedent and retreat to the periphery following a year of assertive constrictions, awaiting a "compilation of proof" to corroborate or refute additional increments. Markets are predominantly valued for reductions later this year and in 2024, so if central banks are ultimately compelled to recommence constrictions due to unrelenting inflation and surplus demand (not our foundational scenario), the bond market would confront a potentially agonizing recalibration.
The BoC executed a widely-anticipated 25 bp increment in January, and although we presumed it to be the cycle's finale, the bank's transition to the sidelines proved more unambiguous than foreseen. The Governing Council stated that if the economic outlook unfolds as predicted—with the BoC maintaining its view of Canada's economy plateauing in forthcoming quarters—it will sustain the overnight rate at its present level. Governor Macklem expounded that an "accumulation of evidence" supporting additional hikes would be necessary for the BoC to recommence tightening.
We believe this approach is prudent, considering the delays inherent in monetary policy's impact on the economy. The 425 bps of increments implemented over the previous year will be more intensely experienced by households in 2023, pushing average debt servicing expenses to a historic peak and diminishing consumer spending, in our opinion. Retreating from the heightened data dependence advocated in December reduces the likelihood of the BoC over-constricting monetary policy by adhering to lagging (and capricious) indicators such as employment figures.
The BoC's guidance should render March's meeting relatively unremarkable compared to recent standards. April's meeting and MPR likely constitute the earliest juncture at which the BoC would possess sufficient evidence to resume tightening, but we do not anticipate the data trending in that direction. Canada's economy entered 2023 with minimal momentum. StatCan's preliminary Q4/22 GDP estimate (+1.6% annualized) fell beneath our assessment of the economy's potential growth rate (marginally above 2%) for the first time in six quarters.
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