The Canadian economy's recent solid run has turned what was a potentially interesting Bank of Canada interest-rate decision this week into another no-change event. But there will still be compelling reading in the central bank's economic outlook – and how it balances the prospects for growth with the dangers of a whole new set of risks, especially those posed by the incoming U.S. administration.
The financial markets are pricing near-certainty (99.2 per cent, in fact) that the Bank of Canada will hold its key rate at 0.5 per cent when it unveils its first rate announcement of the new year on Wednesday. That would mark the 12th straight decision, dating back a year-and-a-half, that the bank has stood pat on rates.
The much more critical element to the day's news will be the bank's quarterly Monetary Policy Report, which will provide considerable new detail about the bank's expectations on rates, inflation and the country's overall economic prospects – including specific new forecasts for economic growth and inflation for 2017.
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As ho-hum as the rate decision itself now looks, it actually represents a significant sentiment shift since the bank's last MPR, in mid-October. At that time, the bank cut its growth projections for the rest of the year; for 2017, it trimmed its inflation outlook and pushed back its projection for when the economy would return to full capacity. While it all implied that the bank's interest-rate increases were further in the distance than previously thought, Bank of Canada Governor Stephen Poloz went further: He revealed, in a news conference, that he and his colleagues had "actively discussed" a rate cut, before deciding that they wanted to wait longer, for a host of uncertainties hanging over the economy to play out.
The implication was that a rate cut was in play unless conditions improved; the most likely timing was the January rate announcement, to coincide with the next MPR, and, thus, the bank's next chance to explain its thinking in written detail. Markets quickly priced in a one-in-four chance of a January rate cut.
But conditions did improve, and so did the outlook for rates. Critically for the Bank of Canada, the country's trade balance has pulled a stunning about-face, from a record deficit in September to the first surplus in more than two years in November (the latest data available). Exports, a vital cog of the central bank's economic recovery plan, are showing strong momentum again after sputtering through much of the year.
Meanwhile, job creation is on a tear. Over the past four months, the economy has added an estimated 175,000 net new jobs – more than it had over the previous 19 months before that.
Economists now believe fourth-quarter economic growth was probably about 1.8 per cent, stronger than the 1.5 per cent that the Bank of Canada projected in the October MPR. What's more, Statistics Canada recently revised upward its GDP estimates for the first and second quarters of 2016. It suggests that economic growth for 2016 may have been a bit brighter than the Bank of Canada had previously calculated.
And the Bank of Canada's own Business Outlook Survey, released just last week, pointed to a long-awaited pick-up in business investment in the next year – a key ingredient to the central bank's vision for the economic recovery.
The question, though, is whether the solid end to 2016 and the rising sense of business optimism will translate into a meaningful upgrade for the central bank's projections for 2017. The consensus forecast among economists, compiled by Bloomberg, is for the economy to grow by 1.9 per cent in 2017 – actually a shade below the Bank of Canada's October forecast of 2 per cent.
There is one school of thought that the Bank of Canada's forecasts will err on the cautious side in light of the new uncertainties to Canada's outlook, especially on the trade front, posed by the election last November of Donald Trump as U.S. president. Mr. Trump comes to the office with an aggressively protectionist trade agenda, and has been increasing his threats on the trade front in the weeks leading up to his Jan. 20 inauguration. On the other hand, Mr. Trump's policies may also represent an upside risk to the Canadian outlook, as his spending plans could accelerate U.S. growth and demand.
Given how important trade and U.S. growth are to Canada's outlook, the MPR will certainly have to address the Trump presidency in some way. But many economists expect the Bank of Canada to play it close to the vest, more or less holding the line on its forecasts and keeping any Trump-related assumptions out of the equation until there is some semblance of clarity about Mr. Trump's policies.
"The bank will probably conclude that it would be more prudent to wait a few more months for more details on the incoming Trump administration's plans. As it stands now, it is impossible to tell whether the proposed policies would have a net positive or negative impact on Canada's economy," economist Paul Ashworth of Capital Economics said in a research report.
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David Parkinson