Economic momentum is fading. Last Friday's release of the Canadian retail sales report showed a rare back-to-back decline in the volume of sales for the months of July (-0.1% m/m) and August (-0.7% m/m). While it is premature to strongly affirm that this sudden decline is entirely due to the 25 basis points BoC policy rate hike of mid-July, this new soft spot raises some concerns. After all, consumers haven't coped with a rising debt-servicing ratio for a very long time (see chart). Given the elevated household debt burden, an increasing debt servicing could be enough to weigh down on discretionary spending.
In addition, we have not observed sufficient progress in CPI and wage inflation lately to justify an imminent BoC rate hike. Furthermore, OSFI’s new B20 guidelines are expected to restrain the purchasing power of prime mortgage borrowers next year. Altogether, market participants are expecting a more dovish BoC statement on Wednesday. We see the overnight rate target ending 2017 at 1.00%.
This being said, one new tailwind for the Canadian growth and inflation outlook could come from today's federal fiscal update. The federal government is poised to spend some of the unexpected surge in fiscal revenues towards additional growth-friendly policies for the middle class, notably a possible enhancement of the Child Care Benefit program. Thus, even though the deficit for FY 2017-18 will turn out to be much smaller than the $28.5B March budget estimate (1.3% of NGDP), market participants do not anticipate the federal government to eliminate the deficit faster over the medium-term.
