Bank of Canada’s Decision Preview: Holding on to the neutral bias until it goes better or worse
The Bank of Canada will emerge from a relatively silent period since its Sept. 4 monetary policy decision. But, in our view, the reasons supporting its neutral bias haven’t change since then. On one hand, housing activity is strengthening, wage growth is accelerating, CPI inflation measures are close to the 2% target and monetary easing by other central banks in the world has led to lower borrowing costs for Canadians.
On the other hand, trade tensions continue to weigh down on the global outlook. The autumn business outlook survey indicated that some Canadian firms cited trade tensions as one factor impacting their sales outlook and, therefore, their investment intentions.
Another factor affecting the BoC’s stance is financial vulnerability, as briefly mentioned by Deputy Governor Larry Schembri in his Sept. 5 speech. We think he implicitly meant that a lower policy rate would be detrimental to long-term financial stability with respect to household indebtedness. Altogether, the bar remains high for the BoC to shift to an easing (or hiking bias) this Wednesday, Oct. 30.
In our view, a global recession would be the main factor leading the BoC to start signalling rate cuts. If our muddle-through outlook turns out to be right, we see the current 1.75% overnight rate target to be maintained throughout 2020. Market expectations are close to our forecast, pricing less than a full 25 bps cut next year.
Finally, one misconception we still hear sometimes is that the BoC would have to reduce its policy rate once the Fed brings down its Fed funds target rate below the overnight rate target in order to prevent a strong appreciation of the Canadian dollar. However, just a friendly reminder, that the BoC’s mandate is low and stable CPI inflation, not a weak Canadian dollar.
Real GDP expected to show no growth for a second consecutive month
On Thursday, we expect 0.0% real GDP growth for the month of August, lower than the 0.2% consensus. If that turns out to be the case, it would mark a second consecutive month with no growth, a first since the back-to-back negative prints of November and December 2018. Underpinning our call is a modest decline in goods-producing industries offset by an increase in services-producing industries. Oil and gas extraction is likely to have fallen again after a shutdown following an oil spill at Newfoundland’s largest drilling Platform, Hibernia, continued well into August.
Due to colder-than-usual weather, we also anticipate a modest decline in utilities production. In addition to manufacturing production, strong housing starts and investment data in August should provide a modest boost to GDP.
On the services side, a large decline in wholesale trade was the largest single detractor to growth while other services slightly expanded. Overall, with a flat print, year-over-year percentage GDP growth would slow down to 1.2% from 1.3% in July; its weakest pace in seven months. Nonetheless, such a growth slowdown in the second half of 2019 was already anticipated by the BoC in its latest decision and, therefore, should not affect its outlook going forward.