The Bank of Canada will be weighing deteriorating economic numbers against an improving global trade climate, as it prepares this week to issue its first interest-rate decision and economic projections of 2020.
The central bank is widely expected to keep its key policy interest rate unchanged at 1.75 per cent in Wednesday’s announcement, the same rate it has maintained for the past 16 months, even as many of its global peers cut rates last year.
But the bigger questions will lie in the bank’s forecasts contained in its quarterly Monetary Policy Report, which will have to incorporate some significant changes in the economic landscape since the bank’s last MPR in October. On the one hand, the outlook will have to address disappointing fourth-quarter economic indicators that suggest growth in the quarter was much weaker than the bank had anticipated. On the other hand, breakthroughs in U.S.-China and North American trade deals have at least partly removed the biggest source of uncertainty dogging the growth outlook, delivering some potential upside to the bank’s analysis.
Certainly the central bank will have to toss aside its previous forecast of a 1.3-per-cent annualized growth pace in the fourth quarter; based on the data to date, economists believe there was little to no growth in the quarter. But signals from the central bank over the past couple of weeks suggest that it will play down the fourth-quarter weakness as an aberration – and that it still isn’t convinced that a rate cut is in Canada’s economic cards.
“I don’t think they’re going to see [the weak data] as too much of a concern,” Conference Board of Canada economist Alicia Macdonald said. She pointed to a news conference earlier this month in which Bank of Canada Governor Stephen Poloz largely dismissed the slow quarter as tainted by temporary factors such as the Canadian National rail strike and a major oil pipeline shutdown. Instead, she said, “Probably [the bank] will focus now on what it has seen from its latest business and consumer surveys.”
Last week, the Bank of Canada’s quarterly Business Outlook Survey and Canadian Survey of Consumer Expectations both showed relatively upbeat sentiment in the fourth quarter, despite the growth slowdown. The business survey showed that companies plan to hire more staff and that they are increasingly bumping against the limits of their production capacity. The consumer survey indicated that Canadians are poised to accelerate their spending.
Critically, the central bank interpreted the increasing pressures on business capacity as evidence the small amount of output slack that it believed remained in the economy “has been absorbed.” That means the economy is essentially operating at full capacity – a condition that would imply that interest-rate cuts are not required to stimulate demand.
The Bank of Canada may also be concerned about consumers’ signals of their spending intentions, given the country’s already near-record household debt loads – something the central bank has long flagged as a potential threat to economic and financial stability. That worry is another key reason the bank is averse to rate cuts, as it fears that lower borrowing costs could stoke further consumer debt accumulation.
Meanwhile, the biggest source of uncertainty hanging over the economy has dissipated since the bank’s most recent rate decision in early December. Canada, the United States and Mexico have cleared away the last roadblocks to their new trade agreement. And last week, the U.S. and China signed a pact that de-escalates the trade war between the economic powers, which had become an onerous threat to the global economy.
“An improving external backdrop also reduces the urgency to lower rates,” Royal Bank of Canada senior economist Nathan Janzen said in a research note.
Looking deeper into 2020, the direction for interest rates is a topic of considerable disagreement. The Monetary Policy Council at the C.D. Howe Institute – the economic think tank’s panel of respected academics and private-sector economics – last week came up with a median prediction that the Bank of Canada’s rate should dip to 1.5 per cent by the end of the year. But the panel was deeply split, with one-third of its members actually predicting that rates would rise.
Ms. Macdonald of the Conference Board said she wouldn’t be surprised if the Bank of Canada holds rates steady for the entire year. But she says she believes the acceleration of wage growth in recent months may eventually tip the scales toward a rate hike.
“We haven’t yet seen the run-up in wages over the past few months translate into higher inflation, but that risk is starting to build a little bit,” she said. “I think [the Bank of Canada] is still tilting more toward the upside, in terms of an [eventual] interest rate increase rather than a decrease.”