The Bank of Canada held its key monetary policy interest rate at 1.75% in today’s decision. The statement released alongside the decision struck a mildly dovish tone. Developments in the energy sector and global trade tensions weigh on the outlook. The Canadian economy has “been performing well overall”, but the Bank is also concerned about weaker-than-expected consumer spending and housing investment. It is perhaps noteworthy that despite the overall tone of the statement, the conclusion that “the policy interest rate will need to rise over time into a neutral range to achieve the inflation target” was the same as provided with their October hike decision.
Also released with the decision was the newest Monetary Policy Report (MPR). Growth expectations for 2018 were left unchanged at 2.1%, but 2019 is now seen as coming in softer, revised down 0.4p.p. to 1.7%. The downward revision to this year was due to by and large to changes in their forecasts for consumer spending and business investment. In contrast, 2020 growth was revised up 0.2p.p. to 2.1%, reflecting a recovery from current weakness. The last Statistics Canada GDP report included significant downward revisions to history, with 2015 and 2016 GDP lower than initially reported. These changes mean that the output gap is now estimated to be in the -1% to 0% range, half a point lower than previously thought.
Expanding further on the forecast change, the biggest development domestically since October’s MPR has been the wild ride in Canadian energy markets as heavy oil prices plummeted before recovering in the wake of mandatory production cuts and recovering refinery demand. Prices may have shot back up, but production cuts will affect the volume of output. In line with our analysis, the Bank of Canada sees near-term weakness, tracking 2018Q4 and 2019Q1 real GDP growth at just 1.3% and 0.8% respectively (q/q saar). However, like us, the Bank of Canada expects a pop-back to above trend growth as 2019 progresses. A back of the envelope analysis suggests that they see quarterly growth averaging an above-trend 2.1% in Q2 and Q3 as the production cuts are dialed down.
Near-term noise aside, the core of the Bank’s mandate is inflation, which has remained tame of late (core measures have been hovering around the 2% mark for most of the year). This is expected to continue. Headline inflation is seen as remaining below target in the near-term before returning to 2.0% by the end of 2019, with a similar pace expected next year. With a wider-than-thought output gap implying some economic slack remains, there is little evidence at present of mounting inflationary pressures.
As always, risks rounded out the MPR. Top of this list was again U.S.-China trade tensions, followed by the oil outlook. Positive risks include the potential for stronger exports and business investment, as well as stronger U.S. growth. Also on the list are the risks of a sharp tightening of global financial conditions, as well as a ‘pronounced’ decline in home prices in Canada.
Key Implications
No big surprise here. The roller coaster ride of the past few months has brought a note of greater caution to the Bank of Canada’s communications, and today’s decision looks to be an extension of that. Governor Poloz and company still see more rate hikes down the road, but aren’t in any great rush to get there.
The cautious stance is justified from a number of perspectives: energy markets can be fickle, and recent developments are a sizeable near-term shock. At the same time, the core of the mandate is inflation, which has both been tame of late and is unlikely to pose a major risk given the Bank’s estimates of economic slack. Thus, from the perspectives of both the core mandate and risk management, there is no fire to fight.
As noted, the Bank’s economic outlook now looks a fair bit like ours. This means that as near-term shocks fade, the Canadian economy should get back on track, with some modest inflationary pressures to match. For this reason we continue to pencil in another rate hike this spring. This is of course contingent on the economy evolving as expected. What’s more, with uncertainty elevated and the Federal Reserve slowing its pace of tightening, it will clearly be some time before we hit the edge of ‘neutral range’ (2.50% to 3.50%).
Note: The Governor and Senior Deputy Governor of the Bank of Canada will speak at an 11:15AM ET press conference.
