The Bank of Canada (BoC) kept its target for the overnight rate at 0.50% this morning. The tone of the statement was less dovish than expected by most market participants because the BoC’s faith that the global recovery will carry on is not fading much despite Brexit.
The BoC basically tells us that Britain's vote to exit the European Union adds a great deal of uncertainty over the global outlook but do not derail the global economic picture: “The fundamentals remain in place for a pickup in growth over the projection horizon, albeit in a climate of heightened uncertainty”. Our central bank notably appears to take some comfort in the fact that “Financial conditions, already accommodative, have become even more so” post-Brexit. It could turn out to be even more the case if the Bank of England eases monetary conditions on Thursday. For the moment, the BoC decided to shave 0.2pp from its global real GDP growth forecast and 0.1pp from its Canadian real GDP growth by the end of 2018 because of Brexit. While we can see this as a modest spillover effect, several pieces of the U.K. and E.U. puzzles are still moving post-Brexit, implying that the impacts of Brexit on the U.K. and the broader global economies are still unclear at this stage.
Brexit is front and center in financial markets but the reality is that the main forces underpinning growth for Canadian consumers and exporters are still the weaker Canadian dollar, the rebound in U.S. economic activity and the coming fiscal stimulus. These friendly fundamentals will ultimately bring the Canadian economy in the right direction, with real GDP growth projected to accelerate from 1.3% this year to 2.2% next year.
Reading the statement almost sounds as if it is virtually business as usual for the Canadian economy despite Brexit ... until one notices the tweak in the last paragraph of the statement in which the BoC seems to share more concerns about household indebtness: “financial vulnerabilities are elevated and rising, particularly in the greater Vancouver and Toronto areas”. While we do not know what the ultimate end game will be on that front, we are pleased to see that targeted measures were recently put in place by the B.C. government to prevent housing affordability from eroding further.
Bottom Line: As we mentioned in our April and May commentaries about the BoC decision, a policy rate hike or a rate cut do not appear to be in the cards until a significant economic or financial shock alters the economic outlook. Moreover, it could remain a card in the hands of BoC if rising oil prices contributed to strengthen the Canadian dollar beyond a certain threshold. Yet, we are slightly surprised by the relatively upbeat tone of today’s statement. As the Bank of Canada’s latest business outlook survey - prior to Brexit - indicated, Canadian companies already had dismal sales prospects for the next 12 months. In other words, it is even less obvious than before to claim that the worse is in the rear view mirror. While we continue to forecast no change in the overnight rate target for the next two years, the fact that downside risks to the global recovery are tilted further to the downside implies that the next move is more likely to be a cut than a hike.