by Sébastien Lavoie
The Bank of Canada (BoC) kept its target for the overnight rate at 0.50% last week. During the press conference held after the release of the statement, one of Governor Poloz’s remarks was that the Governing Council discussed the possibility of additional easing. But the uncertainties surrounding the impact of the new mortgage rules on housing activity and the net effect of the multiple structural and cyclical forces affecting the level of Canadian exports contributed to the decision of not lowering the policy rate.
Firstly, in the MPR, the BoC says that:
“The recently announced federal measures to promote stability in the housing market are expected to lead to weaker resale activity in the near term and a modest change in the composition of residential construction toward smaller units…While household indebtedness has continued to increase, the new measures are expected to dampen household vulnerabilities over time, in part, by improving the average credit quality of new borrowing”.
As for the quantitative effect of the new mortgage rules, the BoC lowered the projected contribution of housing activity (the combination of homebuilding, resale transactions and renovation spending) to real GDP growth by 0.3pp during the 2016-18 period (we can notably infer that the BoC projects a mild 3% decline in housing activity next year since the level of housing activity represents about 7% of real GDP).
This being said, most of the downward revision to the economic outlook is due to the softer profile for the export sector: the positive contribution of exports to real GDP growth was cut by 0.7pp during the 2016-18 period. In the MPR, the BoC cites several reasons behind the weaker export picture, including the competitiveness of Canada against other countries in the US market, rising non-tariff trade barriers, uncertainty about the status of current and future trade agreements and the lower US demand for capital equipment.
Altogether, the case for a policy rate cut is growing because of the housing and export outlooks are subject to considerable uncertainty and also because real GDP and inflation projections were revised down. Altogether, it led the BoC to add two important passages at the end of the statement:
“Given the downward revision to the growth profile and the later closing of the output gap, the Bank considers the risks around its updated inflation outlook to be roughly balanced, albeit in a context of heightened uncertainty. Meanwhile, the new housing measures should mitigate risks to the financial system over time. At present, the Bank’s Governing Council judges that the overall balance of risks is still in the zone for which the current stance of monetary policy is appropriate, and the target for the overnight rate remains at 1/2 per cent”.
For market participants, the main implication of the BoC’s new assessment is that the future releases of housing and export data could increase volatility in the Canadian bond and FX markets in the coming months. If one of these two key sectors of the economy underperforms, it could be enough for the BoC to move out of the sidelines and cut its policy rate.