Weak data test Bank of Canada’s optimistic outlook

Share

Last time we heard from the Bank of Canada, it was raising its 2016 economic forecasts and expressing cautious optimism about the Canadian economy. When the central bank issues its regularly scheduled interest-rate decision this week, we'll get a sense of whether the economy's steady stream of missteps has changed its course.

The bank will issue its rate announcement Wednesday, but the decision itself will not be the news. It's all but a foregone conclusion that the bank will leave its key interest rate unchanged at 0.5 per cent, where it has sat since last July, when the bank made its second quarter-percentage-point rate reduction of 2015.

But in the midst of a spring filled with unimpressive economic indicators, the statement accompanying the rate decision will be far from a non-event. Monetary policy watchers will be combing through the text for any signs that the bank's optimism about a pickup in the economy this year has been shaken.

The tone of the rate statement could be especially big news for the Canadian dollar. It fell to six-week lows last week after the U.S. Federal Reserve released minutes from a recent policy meeting that suggested the Fed is closer to raising U.S. rates than the markets had previously expected, which triggered buying of U.S. dollars at the expense of the Canadian and other currencies. Any hint, even a small one, that the Bank of Canada rates might be on hold for even longer than expected, or perhaps even heading in the opposite direction from the Fed, could fuel more selling of the loonie.

One thing we absolutely will not get from the bank, however, is an actual update of its economic forecasts. While the bank sets rates eight times a year, it only issues its quarterly Monetary Policy Report, which contains its economic projections, in conjunction with half of those rate decisions. This is one of those between-MPR rate announcements; the next forecast update won't come until mid-July.

As a result, observers will have to read between the lines of the rate announcement – which typically runs at a trim half-dozen paragraphs or so – to gauge how the bank's views on the economy have shifted since its mid-April MPR.

The bank's outlook in April was coloured by an impressive start to 2016, which had prompted it to significantly upgrade its economic growth projections for the first quarter and for 2016 as a whole. But the economy sputtered to the end of the first quarter, and carried little momentum entering the second quarter. The economy in the United States, Canada's biggest export market, has also looked persistently lacklustre in recent months, raising doubts about the export demand that was expected to be a critical driver of Canadian growth this year.

The Bank of Canada had already anticipated that the economy would take a second-quarter pause from its unsustainably quick start to the year. It forecast only a modest 1-per-cent annualized growth rate for the second quarter – only about one-third of the estimated first-quarter pace. But in light of the discouraging economic data to end the first quarter, private-sector forecasters now expect near-zero growth in the second quarter.

Many experts have argued that the appreciation of the Canadian dollar over the past four months is weighing on the country's exports, making them less attractive in foreign markets, including the United States, where demand has been looking fragile anyway. The Bank of Canada acknowledged this in the April MPR, when it raised its assumption for the currency for the purposes of its economic forecasts to 76 cents (U.S.), up 4 cents from previous projections. The currency did appreciate modestly in the weeks after the April forecast, but with its recent losses, it is now trading close to the bank's 76-cent assumption; it likely has done little, if anything, to change the central bank's thinking.

On the other hand, another key variable – the price of oil – has increased nearly 15 per cent since mid-April, offering a meaningful boost to the country's beleaguered energy sector and energy-producing regions. The bank may hint at some upside to its economic outlook from the improved oil climate. The bigger question will be whether the price, now approaching $50 (U.S.) a barrel for the North American benchmark crude grade, is yet high enough to entice investment back into the sector. One of the Bank of Canada's big themes in its 2016 outlook has been the precipitous drop in business investment in oil and gas – which it has projected will be 60 per cent lower in 2016 than in 2014 – and the massive impediment that poses to the economy's growth prospects.

But the central bank might also address the Alberta wildfires as a temporary drag on growth in the second quarter, given the sizable disruption to oil sands production. Observers will be looking for any indication of how big a hit on growth the central bank anticipates from the fires, and how much and how quickly it expects the economy to rebound once the affected region restarts production and begins to rebuild from the heavy property damage.

Editor's note: A previous version of this article incorrectly said the Bank of Canada's outlook in April was coloured by an impressive start to 2015. In fact, it was the start of 2016.