Bank of Canada's overnight rate likely to jump around 700% in 2022
The Bank of Canada is gearing up to raise the overnight policy rate later this year. Canadian bond yields have been on the move higher since early last year, bank credit growth has been very strong at over 8% (although bank credit issuance has slowed across the board since September), and unemployment is almost back to where it was before the pandemic. Most importantly, inflation has been coming in well above the bank's 2% target.
Folks are now trying to figure out how high the policy rate will go. Scotiabank, for example, has come out and said that we'll see 2% by the end of the year. That's a 1,250% year-on-year increase from where it has been since last year. It's more likely that we'll see a more modest increase of around 700% year-on-year to get to a rate of about 1.5%.
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BoC OVERNIGHT RATE & 2-YEAR GoC BOND YIELD | CANADA
YOY (%)
Data: Statistics Canada
The overnight policy rate has historically followed fluctuations in the 2-year Canadian bond yield. It happened in 94', 98', 03', 06', and 17'. The only time it deviated was during the Great Financial Crises, when the 2-year yield rose around 100% but the overnight rate soared by over 300%.
The reason for the deviation was likely because the overnight rate dropped too much in 09' (the 2-year yield dropped around 60% but the overnight rate dropped over 90%). To get back to trend, the overnight rate had to over-correct to catch-up. This time around, in early 2020, the overnight rate followed the 2-year closely and dropped about 80%. So, it appears to be safe to assume that the trend continues.
Looking at the 2-year yield, as of the end of January, it's likely that we'll see the overnight rate follow soon and jump by around 700%.
BoC OVERNIGHT RATE & 2-YEAR GoC BOND YIELD | CANADA
PERCENT (%)
Data: Statistics Canada
It terms of how this translates into the rate itself, a 700% year-on-year increase would land the overnight rate around 1.5% using the data for March 2021. While this may seem like a big departure from where it's been for almost 2 years now, that would only bring it about 50 basis points below where it was before the pandemic.
Stay tuned, as I'll cover where mortgage rates will likely go in 2022 next!
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