Rate cut may lurk beneath Bank of Canada’s tame outlook

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The Bank of Canada's newly released economic outlook is, essentially, the forecasting equivalent of a duck.

On the surface, calmly floating along. Underneath, a fury of frantic footwork just to stay in place.

And, with Donald Trump's trade agenda disturbing the waters, drifting perceptibly toward the shores of an interest rate cut.

The central bank held its key rate steady at 0.5 per cent on Wednesday, based on its new quarterly Monetary Policy Report in which it left its economic outlook largely unchanged. The economy is on course to grow a decent 2.1 per cent this year, a tiny upgrade from its previous forecast in October of 2 per cent, more or less balanced out by a tiny downgrade of the inflation outlook (1.8 per cent this year, down from 1.9 per cent).

The bank still sees the economy returning to full capacity around the middle of 2018, just as it forecast in the October report.

But in doing so, the Bank of Canada had to ignore the elephant in the room: U.S. president-elect Trump, who will be sworn into office later this week clutching in his trunk a protectionist agenda that could tear up the rules for doing business with Canada's biggest trading partner.

The central bank certainly didn't deny this; indeed, its rate-decision announcement made it abundantly clear, more than once, that its new outlook is not only riddled with uncertainty, but that it also made no attempt to incorporate the coming Trump trade storm into its forecast. In the bank's view, so little is known for sure about what Mr. Trump will ultimately do on the trade front, and how it will involve Canada, that to work it into the forecasts would be to engage in unhelpful speculation.

Not that the resulting economic forecast was any more helpful. The Bank of Canada knows full well that these numbers will become meaningless the moment Mr. Trump gives notice of re-opening the North American free-trade agreement – something that could happen as early as next week. Exports, business investment, the Canadian dollar – their outlooks will need to be re-written.

The re-opening of NAFTA is just the tip of the Trumpian iceberg, and there aren't a lot of scenarios that aren't a net negative for Canada's economy. Once Mr. Trump lays out his intentions, they may very well deliver the kind of setback to the Canadian economy that would warrant some offsetting help from the central bank to temper the damage – to wit, a rate cut.

But with the bank's key rate at a thin 0.5 per cent, Mr. Poloz knows his ammunition will be pretty limited in the event that Mr. Trump delivers a serious shock to Canada's export sector. So it looks like he is going to considerable lengths not to tip his hand. Don't shoot until you see the whites of their eyes.

Indeed, although the risks to the central bank's outlook now look pretty clearly stacked up to the downside, the bank talked only about "significant uncertainties" in its rate announcement, steering clear of assigning a negative sign to them. And, conspicuously, Mr. Poloz did not formally acknowledge that he and his governing council had considered a rate cut – something he put in writing in his formal opening statement for the Monetary Policy Report in October, the last time the bank updated its forecasts. (The opening statement has become a critical part of the bank's communication on interest-rate policy, as Mr. Poloz uses it to provide insight into the governing council's deliberations and rationale behind its decisions.)

Given that the bank's outlook hasn't changed appreciably since October, and the downside risks have multiplied, the omission was perplexing. Indeed, Mr. Poloz acknowledged, when pressed at the news conference, that, "Yes, a rate cut remains on the table, and it would remain on the table as long as those downside risks were still present."

However, Mr. Poloz said, "Until we have downside risks being actually realized, causing us to doubt whether we can get to that sustainable point [of full capacity in the economy] in that reasonable time frame, then it's appropriate to reach the conclusion that it's not time to try to add more stimulus."

Hence the rationale to leave the mention of rate cuts out of the bank's formal communication. What Mr. Poloz well knows is that once a central bank starts hinting at rate cuts, the financial markets start anticipating them. It would appear Mr. Poloz doesn't want to build that anticipation until he knows that a trade shock is coming and what it looks like.

Would it help for Mr Poloz to be a little more forceful about the possibility of a rate cut? Maybe, especially with Canadian bond market interest rates and the Canadian dollar climbing in the wake of Mr. Trump's election win, which both create headwinds for Canada's economic recovery and appear increasingly wrong-headed in light of the trade threat. But there should be little doubt now that Mr. Poloz has a rate cut at the ready, even if he has decided it's prudent not to say so.