Bank of Canada: No Rate Change but Tighter Forward Guidance than Predicted

January 9, 2019

Canadian monetary policy remains in a tightening cycle intended to converge on rate neutrality. There have already been five 25-basis point hikes of the overnight rate target beginning in July 2017 and with follow-up moves in September 2017, then January, July and October of 2018.

The big decline in the global price of oil resulted in a large drop of Canada’s terms of trade, national income and GDP growth, which officials now project at 1.3% last quarter and 0.8% this quarter. Today’s released statement announcing no change in the 1.75% overnight rate target attributes the dive in oil prices to increases in U.S. oil supply and, secondarily, to worries about global demand.

The central bank’s quarterly Monetary Policy Report was also published, and projected GDP growth this year in Canada was bumped down 0.4 percentage points to 1.7% from the estimate made back in October. Even at the new forecast, however, actual GDP will expand marginally faster than the mid-point of the 1.4-2.2% estimated slope of non-inflationary potential GDP (i.e., its speed limit if inflation is to gravitate toward the 2.0% target midpoint). More importantly, the bank’s Governing Council members do not anticipate that the current lull in growth will persist beyond the current quarter. They instead see a pick-up from the spring onward due to foreign demand, robust immigration, and lower unemployment. Note that immigration has been singled out as a key driver of economic growth. This view contrasts with the belief of the Trump Administration but is consistent with natural world phenomena. Just as steel yields better strength properties than iron, a heterogeneous society has greater creative potential than one constrained to mostly homogeneous expansion.

By 2020, projected economic growth in Canada of 2.1%, revised upward by 0.2 percentage points from the assumption made in October, will be again outstripping the 1.8% middle of the estimated range of potential GDP growth. So while, CPI inflation “is projected to edge further down and be below 2% through much of 2019, owing mainly to lower gasoline prices, inflation will return to around the 2.0% target by late 2019 as transitory effects unwind and excess capacity is absorbed.” On a fourth-quarter over fourth-quarter basis, officials foresee CPI inflation even with the targeted 2.0% in both 2019 and 2020, and this matches their expectation back in October.

Markets had expected a more enduring shift by Bank of Canada officials regarding both growth and inflation. Some analysts were already predicting that any rate change in 2019 would be a cut, not a hike. Alas, the rate statement concludes that the policy rate level has not yet reached the point needed eventually. The only concession was the insertion of the italicized two words in the concluding paragraph of the latest rate announcement.

Weighing all of these factors, Governing Council continues to judge that the policy interest rate will need to rise over time into a neutral range to achieve the inflation target. The appropriate pace of rate increases will depend on how the outlook evolves, with a particular focus on developments in oil markets, the Canadian housing market, and global trade policy.

To borrow a favorite expression of the Federal Reserve, future policy decisions will be data driven in their timing and magnitude, but the biggest takeaway is that the direction of any move this year is most likely to be upward. Of course as in the United State, should the central banks prove to be way to optimistic about the future, all bets are off, and the opinion of market pessimists rather than central bankers will ultimately be proven more accurate.

Copyright 2019, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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