The Bank of Canada looks all but certain to stick with its cautious tune when it issues its latest interest-rate decision this week, as growing economic optimism should take a back seat to tepid inflation and worries on the housing and trade fronts.
Financial markets are pricing in a near-zero chance the central bank will change its key rate from the current 0.5 per cent when it announces its decision Wednesday, one of eight such rate announcements it issues annually. That would extend the bank's stand-pat streak to 15 rate decisions spanning nearly two years.
This is one of the four rate decisions each year that lands in between quarterly Monetary Policy Reports, which means the announcement won't be accompanied by an update of the central bank's economic forecasts. The brief statement will, however, provide the bank's assessment of the state of the Canadian economy, in general terms.
Last time out, in mid-April, the bank played down the economy's strong start to the year, attributing much of the faster-than-expected growth to temporary factors. Since then, key economic indicators have, indeed, been more mixed; but some recent strong data have raised the possibility that first-quarter growth may have topped the 3.8-per-cent annualized pace that the Bank of Canada baked into its April projections. There were more than enough bright spots in March to suggest the economy entered the second quarter with decent momentum – but perhaps not enough to dissuade the Bank of Canada from its recent glass-half-empty leanings on the economic data.
Crucially for a central bank that uses a 2-per-cent inflation target as its formal guide for setting interest rates, last Friday's consumer price index report for April showed an inflation rate of just 1.6 per cent, while the central bank's core inflation measures sat near multiyear lows.
"Despite the many growing arguments for the Bank to turn more hawkish – solid GDP growth, a falling jobless rate, a hot Ontario housing market – subdued core inflation is their ace in the hole, arguing for a stand-pat stance," Bank of Montreal chief economist Douglas Porter said in a research note.
Of more significance may be how the Bank of Canada characterizes the mounting uncertainties threatening the economic outlook.
The central bank has long identified overheated regional housing markets, and their associated heavy household debt burdens, as the key risk to Canada's economic well-being; its focus in recent months has intensified on the runaway Toronto-area market. Those concerns have moved very much to the forefront of public imagination since the bank's last rate announcement, amid the turmoil at mortgage lender Home Capital and Ontario's unveiling of a new foreign-buyers tax to try to quell speculative pressures in the Toronto region.
For a long time, the Bank of Canada was silent on the Home Capital situation; it looked as though Governor Stephen Poloz might wait until this week's rate announcement, if not longer, to talk about the risk the beleaguered lender might pose to the broader financial system. But the central bank chief decided to speak out on the issue in an interview with The Globe and Mail last week, saying that Home Capital's case is "idiosyncratic" and there's no evidence of contagion.
While those comments effectively pre-empted what might have been a key focus of the rate announcement, central bank watchers will still be looking to the statement for additional detail. Observers will also be keen for any glimpse into the bank's currents views on the Toronto housing market, as recent signs have emerged suggesting the beginnings of a cooling.
Meanwhile, the outlook for Canada's trade relationship with the United States, by far its most important market, has if anything darkened since the central bank's last rate decision. President Donald Trump has stepped up his protectionist rhetoric aimed at Canada, while his administration has imposed new duties on Canadian lumber and launched a reopening of NAFTA negotiations that could begin as early as August.
"If only trade policy risks would go away, inflation would quit falling, we had conviction over the durability of strong recent growth, and housing wasn't looking cycle-toppish, then the [rate-policy] hawks would be having a field day," Bank of Nova Scotia economist Derek Holt said.
But with the risks gathering, the outlook on interest rates has instead been drifting toward the dovish camp.
The C.D. Howe Institute's Monetary Policy Council – a group of top Canadian monetary economists that issues its own recommendation on interest rates in advance of each Bank of Canada rate decision – last week said it now expects no rate changes in the next six months, after previously recommending one quarter-percentage-point increase in that time frame. The bond market is now pricing in only a 10-per-cent chance of a rate hike by year end, down from more than 50 per cent in mid-March.
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