The Bank of Canada (BoC) kept its target for the overnight rate at 0.50% this morning, in line with the consensus market expectations.
Hypothetically, it is somehow easy to imagine that the BoC would have been closer to lean on the side of additional easing if it wasn’t for the timely release of the procyclical 2016 federal budget. Fortunately, the reality is that the federal fiscal measures will have a positive effect. In our view, the magnitude and timing of this impact will depend on the households’ willingness to spend the after-tax increase in income suddenly available and how efficiently the infrastructure money trickles down to projects with high multipliers. The BoC expects a “notable” impact of the new federal fiscal measures on real GDP growth in 2016 and 2017, which will ultimately more-than-offset the three main negative shocks incorporated in the new April Monetary Policy Report (MPR) projections:
- The 2016-17 profile for non-resource exports is weaker due to the less favourable global outlook – echoing recent comments made by the Fed Chair Yellen and the IMF– and the stronger loonie.
- The BoC notes that the commodity prices remain historically low despite moving up from their early 2016 lows.
- Consequently, deeper reductions in investment in Canada’s energy sector will be a larger-than-expected drag on economic growth in 2016.
These four macroeconomic changes observed since the January 20th MPR release have changed the composition of Canadian real GDP: mainly, a greater contribution to growth is attributed to government spending and less from exports and business investment. Overall, the net impact is subdued since the new real GDP growth projections were revised a notch upward for 2016 from 1.4% to 1.7% and downward from 2.4% to 2.3%. We also interpret the MPR 2.0% real GDP forecast for 2018, released for the first time this morning, as a sign of a cautious central bank regarding the medium-term global outlook.
Ultimately, the BoC assesses that the combined impact of these four factors did not changed the main takeaway from a monetary policy standpoint. Indeed, the last paragraph of today’s statement contains the same key sentence as before: “Overall, the risks to the profile for inflation are roughly balanced… the overall balance of risks remains within the zone for which the current stance of monetary policy is appropriate”. Our view is that a policy rate hike or a rate cut do not appear to be in the cards until one of the pieces of the puzzle changes or that a new one alters the outlook. For instance, this weekend’s OPEC meeting in Doha could bring the global oil market closer to or further from balance. In turn, this will impact the loonie already going through volatile times and making planning investments difficult for several Canadian companies; the BoC now assumes the Canadian dollar is to stay close to its recent average of 76 US cents over the 2016-18 projection horizon, compared to 72 US cents in January.
In summary, the structural adjustment of the Canadian economy to lower oil prices and weaker exchange rate environment is progressing, albeit slowly. Also, it is somewhat easier for the BoC Governing Council to deliver a new MPR outlook today than it was on January 20th when pessimism took hold of global markets. Accordingly, we are revising our year-end 2016 and 2017 forecasts for the overnight rate target from 0.25% to 0.50%. This being said, even if the worse appears to be in the rear view mirror, we do not see how the BoC will be able to increase its policy rate in 2016 or even 2017, as some market participants are currently forecasting. Our view is based on the premise that the total public-private debt burden of our economy is too elevated to absorb higher rates without harmful consequences. This risk does not seem to be abating. As the BoC notes at the end of its statement, “financial vulnerabilities continue to edge higher”.