October 2016

October 19, 2016

Dovish BoC actively discussed cutting rates

As widely expected, the Bank of Canada left the overnight rate unchanged at 0.50% today. However, the message was very dovish. While the central bank expects Canadian growth to be above potential in the second half of the year thanks in part to the federal fiscal stimulus, it still lowered its growth forecasts for both this year and next, meaning that the profile for growth is now lower than projected last July. The BoC says this is due to slower near-term housing resale activity and a lower trajectory for exports. It added that the new measures to promote stability in the housing market “are likely to restrain residential investment while dampening household vulnerabilities”. The central bank was also less optimistic about trade due to “lower estimates of global demand, a composition of U.S. growth that appears less favourable to Canadian exports, and ongoing competitiveness challenges for Canadian firms”. While it thought the global economy would regain momentum in the second half of the year, driven in part by the U.S., the central bank was still cautious as evidenced by a downgrade to its world growth forecasts to just 2.8% this year and 3.2% in 2017.

Press conference:

In his opening statement, Governor Poloz recognized that, despite recent improvements, the level of exports remains below what was projected in the last MPR. The shortfall is explained in part by weak U.S. growth but also appears to be due to more structural factors. The Governor also talked about the new measures implemented by the federal government to address concerns about household indebtedness (e.g. mortgages) which would, however, have a negative impact on growth over the near to medium term. Those factors explain the downgrade to the BoC’s Canadian growth forecasts. In that context, the Governing Council “actively discussed” the possibility of adding monetary stimulus. However, it decided to stand pat, preferring to wait for more data. The Governor welcomed the new macro-prudential measures, saying that they ease constraints on the Bank of Canada in deciding on monetary policy. For instance, although lower rates would likely lead to more debt, the quality of the loans would be better, thereby mitigating risks to financial stability.

Bottom line:

The Bank of Canada’s statement was rather dovish despite the no change decision on rates. The central bank lowered its Canadian growth forecasts for both this year and next, leaving the output gap open until mid-2018. While that’s just two quarters later than the previous forecast, the central bank qualified the change as “material”. The BoC is clearly communicating that rate hikes are not on the horizon. What about rate cuts? That’s a possibility, more so considering it was “actively discussed” at today’s meeting. But Governor Poloz did not sound overly confident about the BoC’s forecasts during the press conference, recognizing there may be upside risks particularly with regards to housing. Note that the federal government will soon release its 2017 immigration target which is expected to be increased significantly from its current level of 300,000/year. If that pans out, housing demand in Canada’s largest metropolitan areas will get a boost. We still believe the next move by the BoC will be a rate increase albeit delayed to 2018 given the central bank’s view about the output gap.

Paul-André Pinsonnault/Krishen Rangasamy

Senior Fixed Income Economist/Senior Economist