Bank of Canada makes interest rate announcement

by Theophilos Argitis

The Bank of Canada kept interest rates on hold, warning it would remain “cautious” when considering future hikes as it gauges the economic impact of gains in the Canadian dollar and higher rates.

Policy makers led by Governor Stephen Poloz left the benchmark overnight rate at 1 percent Wednesday, pausing after consecutive hikes at the bank’s last two decisions in July and September even as they acknowledged rates are likely to go up.
The Canadian dollar is weighing on inflation and exports, the Bank of Canada said in its statement, while there seems to be evidence of continued slack in the labor market despite recent strong economic growth.

“While less monetary policy stimulus will likely be required over time, Governing Council will be cautious in making future adjustments to the policy rate,” policy makers said. “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.”

Key Takeaways

Following a jump in the Canadian dollar, the Bank of Canada may be trying to curb expectations for accelerated rate increases as the economy runs up against its capacity. The gain in the currency loomed large in the rate statement and quarterly Monetary Policy Report. The higher loonie -- which is up 9 percent since early May -- will delay a return to 2 percent inflation to the second half of 2018 (from the middle of 2018 in the July MPR) while curbing projected export growth, the central bank said. The Bank of Canada doesn’t want to definitively assert the output gap is fully closed. The MPR projects the output gap is zero in the third quarter, but the statement cites an economy that is operating “close” to its potential and highlights plenty of slack in the labor market. The central bank is also assessing whether the economy may have more potential than assumed. “This suggests that there could be room for more economic growth than the Bank is projecting without inflation rising materially above target.”

Other details:

The Bank of Canada assumed that households are more sensitive to higher interest rates, citing recent changes it is making to its modeling to take this factor into account. It said housing and consumption are slowing because of both regulatory changes and higher interest rates. The central bank cited a “notable shift” toward protectionism as the most important source of risk, specifically the renegotiation of the North American Free Trade Agreement. Policy makers have already begun to incorporate uncertainty about trade into their growth forecast, assuming it will lower investment growth by about 0.7 percentage points and export growth by about 0.2 percentage points in 2017 and 2018. The Bank of Canada said it is “mindful” that structural factors could be weighing on inflation Gross domestic product growth is forecast at 3.1% in 2017, 2.1% in 2018 and 1.5% in 2019, from 2.8%, 2% and 1.6% in the July MPR. Potential output growth meanwhile was raised to 1.5% for 2018-19. “As such, economic activity is forecast to remain close to full capacity and at times possibly modestly above, depending on how the supply side of the economy evolves.” Growth is expected to slow to 1.8% in the third quarter this year as exports “temporarily decline”, before picking up to 2.5% in the fourth quarter supported by a pick-up in business investment buoyed by the launch of some large projects. The decline in the unemployment rate “likely overstates the degree of improvement in the labor market.” The labor market isn’t yet “a source of inflationary pressures and that opportunities for further expansion of employment remain.” Pass-through effects of the stronger Canadian dollar are expected to peak at 0.5 percentage points in the second quarter of 2018. Tighter mortgage underwriting rules recently announced by Canada’s banking regulator will subtract about 0.2 percent from the level of GDP by the end of 2019.

Copyright Bloomberg 2017