Bank of Canada holds rate, but darker outlook signals cut ahead!

The Bank of Canada could soon capitulate and cut interest rates because of the trade wars.

Canada’s central bank left its benchmark interest rate unchanged at 1.75 per cent on Oct. 30, as hiring has been strong and inflation is on target. The new policy statement said “choppy” consumer spending will be supported by “solid income growth,” while lower mortgage rates are driving a rebound in housing.

But policy makers seem wary that the country’s run of relatively good fortune will last for much longer.

Governing Council is mindful that the resilience of Canada’s economy will be increasingly tested as trade conflicts and uncertainty persist

Bank of Canada

They cut their outlook for global economic growth in 2019 to 2.9 per cent, the weakest since the financial crisis, and said Canada’s gross domestic product will expand only 1.6 per cent next year, compared with a previous estimate of two per cent.

That rate of growth would be slower than the central bank’s estimate of how fast the economy can expand without triggering inflation (1.7 per cent), suggesting Governor Stephen Poloz and the rest of his policy committee could feel compelled to cut interest rates in order to resist disinflationary pressures. The Bank of Canada sees exports and investment contracting temporarily in the near term due to weaker demand, uncertainty and the transportation constraints that continue to limit shipments of Alberta oil.

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“Governing Council is mindful that the resilience of Canada’s economy will be increasingly tested as trade conflicts and uncertainty persist,” the Bank of Canada said in the statement.

An interest-rate cut at the central bank’s next policy meeting in December or early next year would meet the expectations of many on Bay Street. More than 30 central banks have eased monetary policy this summer and most analysts think it is only a matter of time before Canada follows.

The elephant in the room is the divergence of the Bank of Canada and the rest of the world

Thorsten Koeppl, an economics professor at Queen’s University

“Domestically, everything looks super good,” Thorsten Koeppl, an economics professor at Queen’s University, told me in an interview. “The elephant in the room is the divergence of the Bank of Canada and the rest of the world,” he added. “You see what other central banks are doing. That’s a signal.”

Investors will take note of the Bank of Canada’s mention of the dollar’s recent strength, which hurts the competitiveness of Canadian exporters that the central bank routinely characterizes as relatively uncompetitive. Policy makers aren’t guided by a particular exchange rate, but they know that a stronger dollar will crimp exports, which would slow economic growth and put downward pressure on inflation.

“Commodity prices have fallen amid concerns about global demand,” the central bank said. “Despite this, the Canada-U.S. exchange rate is still near its July level, and the Canadian dollar has strengthened against other currencies.”

To be sure, an interest-cut isn’t a sure thing. The central bank is wary of re-igniting the household debt binge that emerged as a significant threat in recent years. For now, policy makers think Canadians will use their higher wages to pay off some of that debt, but acknowledge that lower borrowing costs could trigger the opposite.

Fiscal policy also could end up doing some of the work of offsetting weaker global growth, if politicians make good on some of their election promises.

“In considering the appropriate path for monetary policy, the bank will be monitoring the extent to which the global slowdown spreads beyond manufacturing and investment,” the statement said. “It will pay close attention to the sources of resilience in the Canadian economy — notably consumer spending and housing activity — as well as to fiscal policy developments.”