Interest Rate Decision – No Change

The Bank of Canada has made its interest rate decision – no change.  Following two consecutive interest rate hikes, the overnight rate was held at 1%.   Everyone was expecting a breather on interest rate increases as the market digests the earlier rate increases.  No doubt the latest announcement from OSFI (The Office of the Superintendent of Financial Institutions) played a role in a more cautious stance.

The central Bank also released its quarterly Monetary Policy Report (MPR) today.  The report forecasts growth of 3.1% this year, 2.1% in 2018 and 1.5% in 2019.  Over the past four quarters, growth has exceeded expectations which no doubt lead to the earlier rate increases.  Moving forward, the Bank of Canada forecasts GDP to moderate to more sustainable levels.

Growth Outlook

Moving forward the Bank expects growth from exports and business investment.  In contrast, the central Bank expects housing and consumption to slow.  They noted, “housing and consumption are forecast to slow in light of policy changes affecting housing markets and higher interest rates.” The Bank went on to say that “because of high debt levels, household spending is likely more sensitive to interest rates than in the past.” 

According to the Bank’s forecasts, expectations are that global growth will be 3.5% during 2017 – 2019.  There is a lot of uncertainty surrounding geopolitical developments such as tensions with North Korea and the United States of America.   Another potential speedbump for growth is the renegotiation of NAFTA currently ongoing. Major developments in these ongoing sagas would lead to adjustments in the Bank’s forecasts.

Inflation Still Not Present

Measures of core inflation have increased as expected but at a much slower pace than the Bank predicted.  The Bank of Canada now predicts inflation will rise to 2% in the second half of 2018 due to recent strength in the Canadian dollar.

The big question is, how fast can the economy grow without triggering inflation?  The Bank of Canada will publish a full report on this in April 2018.  The Central Bank’s target inflation rate is 2%.  The higher the growth level, the lower the estimated level of the “neutral” nominal policy rate – the level of overnight rate that would be consistent with target inflation rate.

The Governing Council now estimates the neutral rate to be between 2.5% and 3.5%.  In other words, the Governing Council of the Bank of Canada estimates the overnight rate will rise from 1% currently to 3% once the economy has reached full employment.  That is a substantial increase from today and would undoubtedly slow interest-sensitive spending, primarily, the housing sector.  It makes you wonder if OSFI and the Bank of Canada are working together as both are intent on tightening credit.

What’s Next for Interest Rates?

The tone in this interest rate decision seems decidedly more dovish than the previous two meetings.  Why the change of stance?

Firstly, the Bank of Canada faced a lot of scrutinies for unexpectedly raising rates in consecutive meetings.  Secondly, the Bank sees significant risks to the outlook, including:

  • Canadian exports being vulnerable to a more protectionist trading partner from the U.S.
  • A more substantial impact of structural factors (Internet, digitization, robots) and prolonged excess supply on inflation
  • Stronger real GDP growth in the U.S. (deregulation and tax cuts)
  • Rising household debts and consumption spending
  • A correction in the housing market

The Bank of Canada sees the risks to inflation as balanced.  This means inflation is just as likely to exceed forecasts as it is to undershoot them. Because of this, future interest rate decisions will be data dependent.   The release stated:  “while less monetary policy stimulus will likely be required over time, Governing Council will be cautious in making future adjustments to the policy rate. In particular, the Bank will be guided by incoming data to assess the sensitivity of the economy to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation. “