Bond and currency traders will be reading every carefully chosen word in Tuesday’s Bank of Canada rate-setting announcement, after recent weak economic data has raised the possibility for the first time in months that the central bank may tweak its outlook on interest rates.
No one expects the Bank of Canada to change its key overnight interest rate from 1 per cent, where it has sat for more than two years. But the question is whether the long-standing “tightening bias” it has included in the statement released with its eight-times-a-year rate decision – a single sentence indicating that “over time, some modest withdrawal of monetary stimulus will likely be required” – could be altered or dropped altogether in light of weakening economic data, especially last week’s report that Canadian gross domestic product grew at an anemic 0.6 per cent in the third quarter.
The bias sentence has long been taken by the markets to mean the bank continues to lean toward rate hikes as its next logical direction – the implication being that economic growth has continued to moving the bank closer to a hike. But any change to the tightening-bias language, experts said, would indicate deepening concern about the economy’s staying power. It would also force most market participants to alter their thinking – and could trigger knee-jerk downward pressure on the Canadian dollar and bond yields.
“Since we’re sitting just above parity [with the U.S. dollar], it would be likely we would move towards or through parity,” said Camilla Sutton, Scotia Capital’s chief currency strategist.
She said the dollar’s weakening would happen quickly – moving to or below parity within the day – “but it would be fairly limited in how far it moves.” By Wednesday, as attention returns to U.S. fiscal-cliff negotiations and the possibility of more quantitative easing, the Bank of Canada statement’s effect would drift out of the market.
While the Canadian dollar may have an initial reaction, Ms. Sutton says, “it’ll take a significant surprise to really shift things.”
If the central bank acknowledges Canada’s weak third-quarter economic performance, it would be “slightly negative” for currency value and bond yields, said Eric Lascelles, chief economist with RBC Global Asset Management.
But Mr. Lascelles doesn’t believe the Bank of Canada will get rid of its tightening bias altogether. Even though he subscribes to the notion that Canada’s economy is faltering, “if there were to be a tweak, it would be toward a softer statement … but I’m not getting a sense that they’re willing or ready to abandon that tightening bias.”
Mr. Lascelles points out that the Bank of Canada must account for the interplay of two things in determining its language: Yes, Canada’s dealing with poor economic showing, but the global economy is turning around, with the U.S. and China in particular gaining momentum.
Ms. Sutton has a similar sentiment. “Even though we’ve seen some negative news on the domestic front, the global front is actually going to offset that,” she said.
“So I expect what we get, in terms of a tightening bias, is very much what we heard [in the previous statement] in October.”
Central bank governor Mark Carney announced last week that he had been appointed to head the Bank of England in mid-2013, making room for a new governor in Canada. Both Ms. Sutton and Mr. Lascelles suspect Mr. Carney will stay the course with 1-per-cent interest rates, though Mr. Lascelles said a new governor may change the bank’s approach to interest rates and inflation once he or she takes over in the middle of next year.
The Bank of Canada’s overnight rate – the target one-day interest rate it sets for financial institutions to borrow or lend among themselves – is closely monitored, as it influences other interest rates that affect consumer debt and currency value.