The Bank of Canada (BoC) has moved firmly into the hawkish camp, with a rate hike to 1% this month, leaving the market expecting one more rate hike this year. The benchmark rate was raised to 0.75% in July.1 Recent economic data continues to surprise to the upside.
Canadian GDP growth leads the developed world at 4.6% year-over-year (as of May), while inflation remains low at 1.2% year-over-year.2 The 10-year Canadian government bond yield topped out at 2.05% at the end of July, and then promptly turned lower.3 We believe the Bank of Canada tone is hawkish enough to imply a continued risk of higher interest rates and an appreciating Canadian dollar.
Below is the latest outlook for global interest rates from the Invesco Fixed Income team.
Inflation data continue to surprise to the downside. This does not mean a December rate hike is off the table, but continued weakness could cause the Fed to question its forecasts. Nevertheless, the Fed remains on track to begin its tapering of reinvestments in September and we expect inflation to show signs of stability in late 2017. This inflation backdrop, together with robust global growth, will likely pressure U.S yields higher as term premium becomes priced in.
As European growth continues to perform well and broaden out, a move away from ultra-loose monetary policy seems inevitable and widely expected at this time. We expect the European Central Bank’s (ECB) approach to exit from its current unconventional policies to be very gradual and cautious to minimize market disruption, as it assesses the future path of inflation (which remains well below the ECB’s 2% target), financial conditions and global growth. We think the ECB will reassess its monetary policy and announce further tapering of asset purchases in October, with a reduction from €60 billion to €40 billion initially, to take effect in January.
The onshore Chinese government bond (CGB) yield curve bear steepened last month, as the central bank maintained relatively tight liquidity conditions in the interbank market while local government bond supply and credit extension have been strong. Liquidity conditions could tighten further in September given quarter-end effects – smaller financial institutions could face funding strains, although liquidity conditions for large banks should remain stable. In the medium term, we continue to see room for interest rates to decline, as tighter financial regulations and strengthened financial deleveraging efforts following the National Financial Work Conference are expected to reduce risk appetite and slow broader credit growth.
Japan just announced its sixth consecutive quarter of growth, the longest unbroken streak in over a decade. What is most impressive is that growth was broad-based and not reliant upon a temporary boost in inventories. More importantly, the consumer continues to play a major part. It is not clear what changed consumers’ mindset, but a mild pick-up in wages, positive wealth effect and a rise in full-time employment likely played a part. Looking ahead, we think the Bank of Japan (BoJ) will keep monetary policy unchanged, although a change in stance cannot be ruled out if other global central banks tghten. We expect 10-year Japanese Government Bond yields to remain range bound (0-0.1%) in the near term.
U.K. economic growth forecasts for the rest of 2017 may be too pessimistic. Many forecasts are based on the consumer making less of contribution than in the past (household savings are at a record low, real wages are negative, property price increases are slowing). But recent data suggest that a slowdown may take longer to play out. The household savings ratio understates the amount that consumers have put away for a rainy day, employment is holding up, inflation is expected to decline and home prices are holding up, so far. A weaker sterling is also helping exports and the U.K. government will likely continue to try to demonstrate that it will not allow the economy to fall off a cliff (over Brexit), meaning there is a chance for a positive growth surprise. Brexit discussions could become factious over the coming months, however, and we expect the Bank of England to keep monetary policy unchanged through year-end.
The Reserve Bank of Australia (RBA) held its benchmark interest rate steady at 1.50% as expected at the August meeting.4 Annual inflation remains below the RBA’s target band and the unemployment rate remains elevated at 5.6%.5 The housing market remains robust and that, combined with low inflation and stubborn unemployment and wage growth, should keep the RBA on hold for the foreseeable future. We remain neutral on Australian interest rates.