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The Bank of Canada has just ensured another 5-cent drop in the loonie

The Bank of Canada did nothing on rates at Wednesday's policy meeting, and the only question is why did the overnight index swap (OIS) market have a nearly 20-per-cent chance of a move priced in?

Only the most obtuse among us could possibly have thought that Friday's jobs data was a game changer, since the overriding story was the 1.1-per-cent contraction in the workweek, which dominated the headline employment gain.

There is no doubt that the Bank is still talking as though the next move (or moves) are going to be rate increases, but the key in the wording in the directive was "over time." In my view, a long time.

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Considering that the Fed is about to tighten policy itself next week for the fifth time this cycle, the Bank could scarcely hint at a rate cut or even that it would permanently stay on the sidelines. So I wouldn't read too much into a de facto tightening bias. The language was squarely on the dovish side, and the Canadian dollar and the front end of the yield curve figured this out very quickly.

With regards to the U.S. economy, growth "is still expected to moderate in the months ahead".

As for the global outlook, well it "remains subject to considerable uncertainty." Not just plain old uncertainty — considerable uncertainty!

When it came to inflation, the Bank of Canada said that this "will continue to be boosted in the short term by temporary factors." So the Bank is deliberately telling everyone that it is going to look through higher-than-expected CPI prints in the months ahead.

The upward revisions to prior output data also "imply a higher level of potential output," which means that the economy's noninflationary speed limit may be higher than previously estimated. And this too affords the central bank more flexibility.

Despite the seemingly bullish employment data, the Bank takes a very eclectic approach, as it should, and concluded that there is "ongoing — albeit diminishing — slack in the labour market." This isn't hawkish!

Finally, the Bank came right out and said at the end of the statement that "the current stance of monetary policy remains appropriate." The question is what makes it inappropriate unless inflation starts to become a problem — yet the Bank already told us that any inflation uptick over the near-term will be viewed as a transitory development.

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Then the Bank of Canada said that it will continue to be "cautious," which is central bank parlance for staying in a wait-and-see mode. And among the laundry list of things the Bank is assessing, one is "the economy's sensitivity to interest rates."

The Bank has had something to this effect in recent press statements, and it is its way of communicating that interest rate movements will have much more profound impacts on economic activity this cycle given the unprecedented volume of debt sitting on household balance sheets.

The consensus seems to think the Bank of Canada is still going to tighten policy three times in 2018. The markets are priced for 2½ hikes (62 basis points versus 74 basis points for the Fed). I like to say "never say never" and so I am not going to say that the Bank is never going again, but what I am saying is that the bar is very high, in my opinion, for the central bank to move off the sidelines. Nothing in this press release changes my opinion on this, by the way.

The uncertainties around the forecast are simply far too wide — trade, housing, bank regulations, fiscal policy, minimum wage hikes and the impact this has on the labour market. A tighter monetary policy would do more to compound these uncertainties that Stephen Poloz et al. are concerned about than alleviate them.

Besides, one has to wonder if the economists on the street calling for two or more rate hikes realize that this would risk inverting the yield curve and thereby raise recessionary risks. And for those that believe that the Bank of Canada is taking unnecessary risks by staying put, just consider that since the beginning of 2016, monetary policy in Canada has tightened, in aggregate, by more than 400 basis points (as per the Bank's old Monetary Conditions Index).

So if I am right on this, with the Bank of Canada being on hold and the Fed living up to its pledge to raise rates three more times, at least, then the impact on the Canadian dollar will be negative. Indeed, the implications for a further deepening in negative Canada-U.S. short-term yield spreads to -75 or -100 basis points from -31 basis points currently would take the loonie to $1.37 or 73 cents (U.S.) even assuming that oil prices stay at their lofty levels.

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So for the next 5-cent move in the loonie, colour me bearish. Do your ski trip in Whistler next year instead of Aspen.

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About the Author
David Rosenberg

David Rosenberg is chief economist and strategist for Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave. More

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