The Bank of Canada (BoC) kept its target for the overnight rate at 0.50% this morning, in line with the consensus market expectations. There was nothing major for financial markets to chew on. In the short 404 words statement, the BoC has nothing new to report and expects more of the same:
“The global economy is progressing largely as the Bank anticipated”;
“Recent data indicate that the U.S. expansion remains broadly on track”;
“The near-term outlook for the (Canadian) economy remains broadly the same as in January”.
Since the January MPR projections were released seven weeks ago, there is clearly no point of making a fuss about nothing. This January MPR indicates better days ahead for the Canadian economy, with real GDP growth accelerating to 1.4% in 2016 and 2.4% in 2017. Despite this brighter outlook, it appears premature in our view to contemplate the idea of a policy rate hike during 2016-17 as some market participants predict. Firstly, the newly elected federal government will announce a large fiscal stimulus program in the March 22 budget. Increasing the overnight rate target would contribute to increase the cost of financing at a time when the federal debt rises. Secondly, a higher policy rate would be a growth headwind for highly-leveraged subnational governments and households. Of course, the big unknown remains the assessment of the positive impact of the federal budget’s fiscal measures on the economy, which will be included in the April MPR scenario. Although we do not have the details yet, the package is more likely to boost growth expectations for 2017-18 than 2016. In our view, the size of the fiscal stimulus would need to be well-above current expectations to engender above-normal growth and significant inflationary pressures in order to justify a higher policy rate.
In summary, a rate hike seems counterproductive and a far-stretched scenario given the complex and long reallocation of resources from the commodity sectors to non-commodity industries. Staying on hold throughout 2016 appears to be the best base-case scenario, as of today. Yet, the possibility of a rate cut, somewhere post-budget, remains appealing. As the BoC noted in its statement, “downside risks remain”. Also, WTI prices and the CAD rebounded from their mid-January troughs. This trend would be reinforced further if a credible agreement is reached within OPEC to first freeze and then cut production in a not too distant future. The problem for the Canadian economy is that, even with WTI prices at US$60-70, high cost oil sand producers will likely not comeback with new investments for years, and maybe forever, as efficient US shale oil producers are crowding them out. At the same time, the stronger currency above 80 US cents associated with the higher WTI oil prices could compromise Canada’s export-led recovery in the making and further unwind the temporary effects of the past depreciation on CPI inflation. Today’s statement shows that the recent rebound in the currency since the trough observed in mid-January is not a source of concern. But if the loonie eventually surged above its “fair value” of 82 US cents for a considerable period of time (the OECD estimates that the purchasing power parity benchmark of the Canadian dollar is 82 cents US), the BoC may consider the possibility of lowering its policy rate or adopting unconventional policy tools.
Also, the BoC may also contemplate further easing if market expectations of Fed hikes eventually comeback on the front burner and lead to a tightening in monetary conditions for our highly-leveraged economy. Somehow, the US-Canadian divergent monetary policy theme, well established in December 2015, seems to have been forgotten too rapidly.
Bottom Line: The stars may not be aligned for a rate cut yet. Nonetheless, the BoC may eventually find itself closer to the verge of additional easing than in a tightening mode at some point during the year. Only time will tell. With this status quo statement behind us, markets will gear up for the release of the LFS reporton Friday. We expect a net job creation of 10K for the month of February, in line with the market consensus. We continue to expect the addition of high-quality jobs in the provinces of BC, Manitoba, Ontario and Quebec to slightly offset the layoffs in Alberta, Saskatchewan and N&L (see charts on page 2). But given that the national unemployment rate has been at 7% or slightly higher during the last six months, the labour market is not close from causing inflationary pressures and becoming a particular concern at the BoC.
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