As the BoC will deliver its first of eight decisions of 2017 next Wednesday, the current monetary policy stance remains appropriate in our view.
Granted, the three new core inflation measures the BoC uses as operational guides decelerated in recent quarters (see chart below) and total CPI inflation has been softer than projected in the October MPR during 2016Q4. However, the upbeat winter edition of the Business Outlook Survey (BOS), released by the BoC last Monday, offers a glimmer of hope for a turnaround in inflation toward the 2% target during the 2017-18 period. Over the next 12 months, Canadian firms’ expectations in terms of sales growth, business investment, and hiring are as good as they were in mid-2014, prior to the decline in crude oil prices (see chart below). Thus, no easing action appears required next Wednesday.
This being said, the story could turn out to be different later this year, since several factors could weigh on Canadian economic activity. The first thing that comes to mind is Trump’s policies. It is still too early to assess their net impacts on the U.S. and Canadian economic outlook, as well as on financial conditions. It will be interesting to see if the BoC includes some form of U.S. expansionary fiscal policy in their January MPR projections (U.S. real GDP growth was projected at 2.1% in 2017 and 2.0% in 2018 in the October MPR), something FOMC members did last December. Another option would be to simply continue highlighting stronger real GDP growth in the U.S. as an upward risk to the outlook.
While the Republican plan to cut corporate taxes and boost infrastructure spending could lift economic growth in the near term, future trade relations are a source of concern in the medium- and long-term (many companies “expressed concern about the risk of rising protectionism” in the BOS). Notably, the proposed border adjustment tax – allowing US companies to exempt exports from their taxable income and taxing U.S. imports – could erode Canada’s competitiveness, unless the USD/CAD appreciates rapidly and sufficiently. This issue is expected to be highlighted in the list of risks the BoC monitors.
Bottom Line: It appears preferable for the BoC to stay on the sidelines to begin the year. Given the elevated level of uncertainty related to the regulatory, fiscal and trade agendas of the new administration in Washington, an overly dovish or upbeat statement both appear unlikely next week. However, the wide range of potential consequences from Trump’s proposed policies, as well as new developments regarding Brexit and political events in the euro zone, could lead to multiple and sudden shifts in market expectations regarding the BoC’s next moves during 2017.
