{"id":2033,"date":"2023-03-10T05:09:15","date_gmt":"2023-03-10T05:09:15","guid":{"rendered":"https:\/\/www.rbc.com\/en\/economics\/2023\/03\/10\/new-legs-or-familiar-lags\/"},"modified":"2025-03-26T04:54:42","modified_gmt":"2025-03-26T04:54:42","slug":"new-legs-or-familiar-lags","status":"publish","type":"post","link":"https:\/\/www.rbc.com\/en\/economics\/financial-markets-monthly\/new-legs-or-familiar-lags\/","title":{"rendered":"New legs, or familiar lags?"},"content":{"rendered":"<h4>Highlights<\/h4>\n<ul>\n<li>Hawkish Fed and ECB look set to raise rates further than we previously thought<\/li>\n<li>But the BoC moved to the sidelines, and could soon be joined by the BoE and RBA<\/li>\n<li>Policy divergence is putting downward pressure on the Canadian dollar<\/li>\n<li>We\u2019re now tracking modest GDP growth in Canada and the US in Q1 but still expect declines in the coming quarters<\/li>\n<\/ul>\n<hr \/>\n<p>After a year of aggressive interest rate hikes, major economies continue to show signs of resilience and in some cases acceleration in early-2023. And core inflation isn\u2019t slowing as quickly as central bankers would like. That raises the question of whether the current economic cycle has new legs\u2014necessitating even higher interest rates to rein in growth and inflation\u2014or if patience is needed as monetary policy acts with well-known lags. Some policymakers are leaning toward the latter. The BoC moved to the sidelines in March and both the BoE and RBA are approaching a pause. But the Fed and ECB think there\u2019s more work to be done. We\u2019ve added 50 bps to terminal rate forecasts for both.<\/p>\n<p>With more tightening in the pipeline, government bonds were on the back foot in February. Treasuries suffered their worst monthly decline since September and Bund yields rose to new cycle highs. US equities fell modestly but stayed well above levels seen four month ago, the last time 10-year yields were at 4%. Yield curve inversion deepened as investors continue to see restrictive monetary policy slowing growth and inflation over time. Despite some upside surprises in recent data, we continue to think the tightening delivered thus far will result in modest GDP declines in the US, Canada and UK, and sluggish growth in the euro area and Australia in the coming quarters. That should create a more constructive environment for fixed income as the year progresses.<\/p>\n<p><center><\/p>\n<h3 id=\"central-bank-bias\" class=\"anchor\"><span style=\"color: #004da4;\"><b>Central bank bias<\/b><\/span><\/h3>\n<p><\/center><\/p>\n<p><!-- Insert style at the beginning of code block --><\/p>\n<p><!-- Central Bank table starts here --><\/p>\n<div class=\"central-bank-table\">\n<!-- Headers --><\/p>\n<div class=\"col-wpr bg-lightblue mar-b-0 pad-tb pad-lr text-center eh-wpr\">\n<div class=\"col-4 flex\">\n<p class=\"h5 text-white\">Central Bank<\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h5 text-white\">Current Policy Rate<br \/>(Latest Move)<\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h5 text-white\">Next move<\/p>\n<\/div>\n<\/div>\n<div class=\"col-wpr table-border mar-t-0 pad-tb pad-lr text-center eh-wpr\">\n<!-- Block 1 CANADA --><\/p>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/www.rbc.com\/en\/economics\/wp-content\/uploads\/sites\/4\/2025\/03\/Central-bank-bias_Canada-Flag.png\" alt=\"\" width=\"626\" height=\"626\" class=\"alignleft size-full wp-image-42691 w-35 pad-r\" \/>BoC<\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">4.50%<br \/><span class=\"h5\">No change in Mar-23<\/span><\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">On hold<br \/><span class=\"h5\">until Q1-24<\/span><\/p>\n<\/div>\n<div class=\"col-12 text-center pad-t\">The BoC held its overnight rate steady in March and reiterated a conditional pause in its tightening cycle. The policy statement was slightly dovish, giving no indication the bank plans to act on its tightening bias.<\/div>\n<\/div>\n<\/div>\n<p><!-- Block 2 USA --><\/p>\n<div class=\"col-wpr table-border pad-tb pad-lr text-center eh-wpr\">\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/www.rbc.com\/en\/economics\/wp-content\/uploads\/sites\/4\/2025\/03\/Central-bank-bias_US-Flag.png\" alt=\"\" width=\"626\" height=\"626\" class=\"alignleft size-full wp-image-42709 w-35 pad-r\" \/>Fed<\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">4.50-4.75%<br \/><span class=\"h5\">+25 bps in Feb-23<\/span><\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">+25 bps<br \/><span class=\"h5\">in Mar-23<\/span><\/p>\n<\/div>\n<div class=\"col-12 text-center pad-t\">Strong data has the Fed sounding more hawkish and we\u2019ve revised our terminal fed funds forecast higher to 5.25-5.50%. We think they\u2019ll stick with 25 bp increments though Chair Powell opened the door to a larger move.<\/div>\n<\/div>\n<p><!-- Block 3 UK--><\/p>\n<div class=\"col-wpr table-border pad-tb pad-lr text-center eh-wpr\">\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/www.rbc.com\/en\/economics\/wp-content\/uploads\/sites\/4\/2025\/03\/Central-bank-bias_British-Flag.png\" alt=\"\" width=\"626\" height=\"626\" class=\"alignleft size-full wp-image-42711 w-35 pad-r\" \/>BoE<\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">4.00% <br \/><span class=\"h5\">+50 bps in Feb-23<\/span><\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">+25 bps<br \/><span class=\"h5\">in Mar-23<\/span><\/p>\n<\/div>\n<div class=\"col-12 text-center pad-t\">The BoE hasn\u2019t sounded nearly as hawkish as the Fed and ECB, and we continue to expect it will downshift to a 25 bp hike in March. We think the market is overestimating tightening beyond the next meeting.<\/div>\n<\/div>\n<p><!-- Block 4 EURO --><\/p>\n<div class=\"col-wpr table-border pad-tb pad-lr text-center eh-wpr\">\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/www.rbc.com\/en\/economics\/wp-content\/uploads\/sites\/4\/2025\/03\/Central-bank-bias_EU-flag.png\" alt=\"\" width=\"626\" height=\"626\" class=\"alignleft size-full wp-image-42708 w-35 pad-r\" \/>ECB<\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">2.50% <br \/><span class=\"h5\">+50 bps in Feb-23<\/span><\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">+50 bps<br \/><span class=\"h5\">in Mar-23<\/span><\/p>\n<\/div>\n<div class=\"col-12 text-center pad-t\">With core inflation continuing to accelerate, the ECB looks set to raise rates even further and we\u2019ve revised our terminal deposit rate forecast up to 3.75%. We expect 25 bp moves after one more 50 bp hike in March.<\/div>\n<\/div>\n<p><!-- Block 5 AUSTRALIA --><\/p>\n<div class=\"col-wpr table-border pad-tb pad-lr text-center eh-wpr\">\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/www.rbc.com\/en\/economics\/wp-content\/uploads\/sites\/4\/2025\/03\/Central-bank-bias_Australia-flag.png\" alt=\"\" width=\"626\" height=\"626\" class=\"alignleft size-full wp-image-42710 w-35 pad-r\" \/>RBA<\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">3.60% <br \/><span class=\"h5\">+25 bps in Mar-23<\/span><\/p>\n<\/div>\n<div class=\"col-4 flex\">\n<p class=\"h3 text-bold text-blue\">+25 bps<br \/><span class=\"h5\">in Apr-23<\/span><\/p>\n<\/div>\n<div class=\"col-12 text-center pad-t\">Dovish language in March suggested the RBA is nearing the end of its tightening cycle. We expect another hike in April will be followed by a pause, though the RBA won\u2019t be as firmly on the sidelines as the BoC.<\/div>\n<\/div>\n<p><!-- End of Central Bank table --><\/p>\n<h4 id=\"title1\" class=\"anchor\">Strong January data has the Fed sounding more hawkish<\/h4>\n<p>After signs that the US economy was losing momentum late last year\u2014private domestic demand was essentially flat in Q4\u2014recent data suggest a surprising resurgence in early-2023. Payroll employment rose by more than 500,000 in January and surpassed market expectations again in February. Inflation-adjusted consumer spending recorded its strongest monthly increase in nearly two years in January, more than retracing declines in the prior two months. And manufacturing output posted its strongest gain in almost a year. Perhaps most worrying for the Fed, headline PCE inflation ticked higher year-over-year for the first time in seven months, and core inflation (and core services ex housing) accelerated on a monthly basis. All told we\u2019ve revised our Q1 GDP forecast higher to 1.0% annualized from flat previously, and our 2023 projections for headline and core CPI inflation have been revised about \u00bd ppt higher.<\/p>\n<p>Warm weather and post-pandemic seasonal adjustment issues might explain some of the strength in January data. And it\u2019s not as if rate increases aren\u2019t having an impact. The US\u2019s housing downturn deepened in January with existing home sales falling to a 12-year low and starts down 20% from a year earlier. Business investment is also softening with capital goods orders little changed in recent months. But the Fed isn\u2019t willing to risk pausing its tightening cycle prematurely, and a number of FOMC speakers have suggested interest rates will have to rise further than December\u2019s dot plot indicated. Chair Powell reiterated that message in March and even re-opened the door to larger rate increases after the Fed downshifted to a 25 bp hike in February. But with February\u2019s jobs data looking soft beyond the headline gain (unemployment rate up, wage growth slowing and hours worked down) we think the Fed will opt for another 25 bp hike in March.<\/p>\n<p>We continue to think monetary policy has become restrictive enough to slow the economy, and the Fed should be mindful of the lagged impact of 450 bps of hikes delivered over the past year\u2014the steepest increase since the early-1980s. The real fed funds rate will also become more restrictive as inflation continues to slow, passively tightening monetary policy even if nominal fed funds is on hold. But with the Fed clearly preferring to err on the side of more aggressive action, we\u2019ve revised our terminal rate forecast 50 bps higher to 5.25-5.50%. We continue to think the Fed will begin to gradually reverse course around the turn of the year.<\/p>\n<div id=\"everviz-TM5FWBn9c\" class=\"everviz-TM5FWBn9c\"><script src=\"https:\/\/app.everviz.com\/inject\/TM5FWBn9c\/?v=2\" defer=\"defer\"><\/script><\/div>\n<h4 id=\"title2\" class=\"anchor\">BoC moves to the sidelines, and sounds comfortable there<\/h4>\n<p>The BoC held the overnight rate steady in March after hiking at each of its past eight meetings (+425 bps cumulatively). Its move to the sidelines was widely expected with January\u2019s statement having clearly signaled a pause and mixed data since then falling well short of the \u201caccumulation of evidence\u201d needed for the BoC to restart tightening. Q4 GDP was disappointing (flat vs. an expected 1.3% annualized increase) though the miss was largely due to slower inventory investment\u2014final domestic demand rose 1%. The BoC made no mention of a rebound in January\u2019s flash GDP estimate, which led us to revise our Q1 growth forecast from a modest decline to a 1% annualized gain (the BoC was already forecasting a 0.5% increase). <\/p>\n<p>We continue to expect Canada\u2019s economy will see some modest quarter declines in 2023, but now in the middle quarters rather than first half of the year. For its part, the BoC expects \u201cweak economic growth for the next couple of quarters.\u201d Unlike January\u2019s statement, there was no mention of \u201cexcess demand\u201d in the economy, though other comments suggested an ongoing supply-demand imbalance. With headline CPI easing and 3-month annualized core inflation running at 3.5%, the BoC maintained its view that inflation will slow to 3% (the upper end of its inflation-control target range) by the middle of the year, in line with our own forecast. But a \u201cvery tight\u201d labour market continues to cause discomfort. The bank pointed to wage growth of 4-5% which, given weak productivity, is well above levels consistent with 2% inflation. With the economy now growing at a sub-trend pace\u2014implying excess demand is easing\u2014it\u2019s hard to see the unemployment rate holding at a near-record low of 5%. Sluggish growth gives the BoC cause for patience but it will eventually want to see the labour market returning to better balance if it is going to remain on the sidelines and not raise rates any further.<\/p>\n<h4 id=\"title3\" class=\"anchor\">Canadian dollar under pressure amid policy divergence<\/h4>\n<p>A hawkish Fed and on-hold BoC has pushed 2-year Canada-US spreads to their tightest levels since 2019. That has put downward pressure on the Canadian dollar which is closing in on October\u2019s lows relative to the US dollar (around 72 cents). Back then, there was speculation\u2014fueled in part by comments from Governing Council\u2014that the BoC might have to continue with aggressive rate hikes to keep up with the Fed and support the currency. But the market was ultimately disappointed when the BoC downshifted to a 50 bp hike in October.<\/p>\n<p>As was the case last year, we don\u2019t think the currency\u2019s recent weakness will have a significant impact on monetary policy. Policy divergence between the Fed and BoC is not unusual\u2014terminal fed funds was 63-100 bps higher than the BoC\u2019s overnight rate in each of the past three major tightening cycles\u2014and not unjustified given faster interest rate pass-through and higher levels of household debt in Canada. And it remains the case that some of the recent depreciation reflects US dollar strength. The Canadian dollar is down by 7% year-over-year against the greenback but only 3% lower against the currencies of Canada\u2019s other key trading partners. In the BoC\u2019s March policy statement, it put the focus on a strong US dollar rather than a weak Canadian dollar. It also pointed to tightening financial conditions, and in our view the recent increase in Canadian bond yields offsets any stimulative impact from a weaker currency. From an inflation perspective, a 5% year-over-year decline in the trade-weighted Canadian dollar will add to import costs but puts only modest upward pressure on broader consumer prices.   <\/p>\n<div id=\"everviz-RfXKh5Jw4\" class=\"everviz-RfXKh5Jw4\"><script src=\"https:\/\/app.everviz.com\/inject\/RfXKh5Jw4\/?v=3\" defer=\"defer\"><\/script><\/div>\n<p><!-- Box --><\/p>\n<div style=\"background-color: #f4f8f9; padding: 25px\">\n<p>\n<b id=\"title4\" class=\"anchor\">Hard landing, soft landing\u2026 no landing?<\/b><\/p>\n<p>Amid ongoing debate over whether central banks will be able to deliver a soft landing\u2014restoring price stability without causing an economic downturn\u2014or if efforts to rein in inflation will cause a hard landing, a new term has emerged recently. Stronger-than-expected data have raised the prospect of a \u201cno landing\u201d scenario in which the economy and labour market fail to slow despite the increase in interest rates over the past year. But would that be acceptable to central banks? Unless their assessments of sustainable levels of economic activity and unemployment are way off the mark, it\u2019s hard to see inflation returning to target in such a scenario. That\u2019s particularly true in Canada and the US where we think overheating is greatest. So \u201cno landing\u201d should be a no-go for the BoC and Fed\u2014it would simply necessitate even tighter monetary policy to slow the economy, increasing the odds of a hard landing in 2024. That remains one of the key downside risks to our outlook. But our base case continues to be that the tightening delivered thus far (425 bps by the BoC and 450 bps by the Fed) will be enough to push the Canadian and US economies into a mild recession this year, restoring better balance between supply and demand and helping inflation return to target.\n<\/p>\n<\/div>\n<h4 id=\"title5\" class=\"anchor\">Accelerating core inflation forces the ECB to do more<\/h4>\n<p>Recent activity indicators for the euro area have been more mixed than in the US. Q4 GDP growth was revised down to flat and domestic demand posted its largest decline (-1%) since the initial pandemic lockdowns. PMI data point to a return to growth in early-2023\u2014the composite reading rose to an eight-month high in February\u2014and consumer sentiment has improved, though soft retail sales suggest actual spending remains lackluster. But it\u2019s the latest inflation data that will have more sway over monetary policy. Headline inflation was stronger than expected in February and core inflation rose to a fresh high of 5.6% year-over-year. While most other advanced economies have seen some flattening or moderation in core readings, the euro area is seeing acceleration. Some of that reflects ongoing pass-through of higher energy prices into broader goods inflation, and we continue to think core inflation will peak on a year-over-year basis in the coming months. <\/p>\n<p>But it looks like lack of progress in taming core inflation will force the ECB to do more. We\u2019ve added another 50 bps to our terminal deposit rate forecast (now 3.75%), expecting a 50 bp increase later this month will be followed by 25 bp hikes through July. The market is pricing in an even higher 4% terminal rate and we think the risk is skewed in that direction. Perhaps more importantly, we don\u2019t see the ECB following the Fed and BoC in cutting interest rates around the turn of the year. Even with inflation slowing, its real policy rate will be only modestly above zero and below past cyclical peaks. With the ECB likely to hold rates at terminal for longer, we don\u2019t see Bunds rallying as much as Treasuries over the next year.<\/p>\n<div id=\"everviz-fTFdIbRxH\" class=\"everviz-fTFdIbRxH\"><script src=\"https:\/\/app.everviz.com\/inject\/fTFdIbRxH\/?v=2\" defer=\"defer\"><\/script><\/div>\n<h4 id=\"title6\" class=\"anchor\">BoE and RBA getting closer to a pause<\/h4>\n<p>Other central banks haven\u2019t sounded nearly as hawkish as the Fed and ECB. The BoE\u2019s chief economist suggested continuing with 50 bp increases would cause the central bank to over-tighten, and we look for a smaller 25 bp hike later this month. Market-implied terminal Bank Rate has been dragged higher alongside the Fed and ECB but we think the BoE will be cautious beyond its next meeting. Headline inflation has peaked and is set to slow further as last spring\u2019s sharp increases in energy prices fall out of calculation. Core inflation is also beginning to moderate, and while wage growth remains too firm, declining job vacancies suggest labour market pressure is beginning to ease. Our forecasts assumes the BoE will be on hold after March with a terminal Bank Rate of 4.25%.<\/p>\n<p>The RBA hike by 25 bps at its March meeting but softened its language on further rate increases and hinted that it might soon be ready to pause its tightening cycle. Weaker-than-expected Q4 GDP growth (including a slowdown in household spending amid tightening financial conditions), early evidence that inflation has peaked, and less concern about a wage-price spiral all contributed to the more dovish tone. We continue to look for one more 25 bp hike in April before the central bank moves to the sidelines. But with monetary policy only modestly restrictive, we think the RBA\u2019s pause will be less firm than the BoC\u2019s and risks around our terminal cash rate forecast are still skewed to the upside.<\/p>\n<p>\u00a0<\/p>\n<h5 id=\"title7\" class=\"anchor\">Download full PDF report including forecast tables:<\/h5>\n<div class=\"rds-callout-white no-print\" style=\"border: 1px solid #c4c8cc;\">\n<div class=\"section-inner\">\n<div class=\"flex align-items-center\">\n    <\/div>\n<div class=\"grid-wpr eh-wpr mar-t-0\">\n<div class=\"grid-half\">\n            <a href=\"https:\/\/www.rbc.com\/en\/economics\/wp-content\/uploads\/sites\/4\/2024\/11\/FMM_Mar2023iv.pdf\" class=\"pdf-link\" target=\"_blank\" style=\"text-decoration: none;\" rel=\"noopener\">Financial Markets Monthly full PDF<\/a>\n        <\/div>\n<\/div>\n<\/div>\n<\/div>\n<p>\u00a0<\/p>\n<style class=\"advgb-styles-renderer\">.table-border { border: 1px solid #E0E0E0;} .w-35{width: 35% !important;} .col-4.flex {    justify-content: center;\n    align-content: center;}.bg-lightblue{background-color:#73b0e3;}<\/style>\n","protected":false},"excerpt":{"rendered":"<p>After a year of aggressive interest rate hikes, major economies continue to show signs of resilience and in some cases acceleration in early-2023.<\/p>\n","protected":false},"author":268,"featured_media":2031,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"advgb_blocks_editor_width":"","advgb_blocks_columns_visual_guide":"","footnotes":""},"categories":[48],"tags":[11],"class_list":["post-2033","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-financial-markets-monthly","tag-economy"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v26.7 (Yoast SEO v26.8) - https:\/\/yoast.com\/product\/yoast-seo-premium-wordpress\/ -->\n<title>New legs, or familiar lags? - RBC 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