The Bank of Canada (BoC) left the overnight rate target at 1.25% this morning.
Similar to January, BoC officials would prefer to cautiously remove further monetary stimulus over time. This being said, they are not even sure another 25bps policy rate increase will occur this year because the risk that protectionist threat jeopardizes the global economy has risen: “Trade policy developments are an important and growing source of uncertainty for the global and Canadian outlooks,” implicitly referring to U.S. President Donald Trump’s steel and aluminum tariffs announced last week. If these punitive tariffs lead other countries to retaliate, the economic and inflation outlook could deteriorate very quickly. Thus, the chances of a few rate hikes this year have diminished. The chances of one or multiple 25bps rate cuts are not 0% either.
In our view, several passages of the statement suggest that the BoC may have to at least delay hikes until the second half of 2018. First, the BoC refers to stronger business investment adding to the economy’s capacity, implying the economy can expand further without CPI inflation running substantially above the 2% target. Second, the BoC highlights softer-than-usual growth in wages in the current context of no labour market slack. Third, the BoC firmly expresses concerns relative to the impact of higher interest rates and restrictive policies on the housing sector: “It will take some time to fully assess the impact of these, as well as recently announced provincial measures, on housing demand and prices.” For instance, MLS residential transactions pulled back significantly in the two largest housing markets (Toronto: -35% year-over-year in February; Vancouver: -9% year-over-year), partially compensated by a 5% year-over-year increase in Montreal. “More broadly, the bank continues to monitor the economy’s sensitivity to higher interest rates. Notably, household credit growth has decelerated for three consecutive months.”
Bottom Line: Similar to the federal government in Ottawa, the BoC hopes for the best and plans for the worst. The BoC heavily leans against the build-up of trade protectionism at this mature stage of the business cycle where “inflation is running close to the 2-per-cent target and the bank’s core measures of inflation have edged up.” The trade protectionism threat clouds the outlook to the point that the range of possibilities regarding the future path of the overnight rate target appears wider than during the 2014-15 oil shock. If these protectionist forces abate, the BoC may need to hike aggressively in late 2018 and early 2019 to catch up on this extra cautious stance. If the threat of protectionist policies fully materializes, however, outright cuts in the overnight rate target could be required.