As we expected, BOC left the policy rate unchanged at 1.75% in yesterday. Policymakers admitted that the decline in oil price has “material” impact on the economy. Yet, they viewed the impact as transitory. Reflecting the view on economy projections, the central bank downgraded the GDP growth forecast for this year, but upgraded it for the next year. Similarly, inflation is trimmed for this year due to weakness in oil prices. On the monetary policy stance, BOC retained the view that interest rates would “need to rise” and the decision would be data-dependent. Yet, this time the central bank added that a rate hike would come “over time” and the pace would highly depend on “developments in oil markets, the Canadian housing market, and global trade policy”.
Much of the discussion was confined to the oil sector. While noting that the domestic economy has been “performing well overall”, the members admitted that the selloff in global oil prices has a “material impact on the Canadian outlook, resulting in lower terms of trade and national income”. They cautioned that “investment in Canada’s oil sector is projected to weaken further”, although the spread between WCS oil price and world benchmark has narrowed recently.
Just like other major central banks, BOC’s core mandate is to achieve its inflation target, which has been set at 2%. Benign inflation has removed urgency to increase interest rates in coming months. BOC forecast inflation to “edge further down and be below 2% through much of 2019, owing mainly to lower gasoline prices”. Meanwhile, household consumption, which has been dampened by the decline in housing prices and softer growth in oil –producing provinces, would remain under pressure as the abovementioned factors remain in play. Yet, policymakers judged that depreciation in Canadian dollar will “exert some upward pressure on inflation”. They expected that inflation would return to around the 2% “by late 2019” as the “transitory effects unwind and excess capacity is absorbed”.
On the updated economic projections, the central bank revised lower GDP growth estimate to +1.7% for 2109, compared with +2.1% projected in October. Growth is expected to pick up to an above-trend rate of +2.1% in 2020, compared with +1.9% projected previously. BOC also revised lower this year’s inflation forecast to +1.7% from +2% previously. The major change in the macroeconomic environment since October is the energy sector. The slump of WCS oil price led the province of Alberta to announce a compulsory production cut. While the cut has triggered price recovery, it has also trimmed GDP growth for the near-term.
The January BOC meeting affirmed our view that the market is too optimistic over the growth outlook in Canada. As such, risk to the consensus rate hike forecasts is to the downside. We expect more upside to USDCAD in the near-term. Strong US economic data should support further rate hike in 1H19, while BOC might continue to stand on the sideline during the period.
