The Bank of Canada got what it was looking for with the Canadian economy's third-quarter comeback. This week, we'll see whether the central bank is feeling nearly as good about the far-less-certain prospects beyond the current rebound – and how that colours the outlook for interest rates.
On Wednesday, the bank will release its latest interest-rate decision, together with its quarterly Monetary Policy Report, containing its closely scrutinized forecasts for the Canadian economy. It's the first update of the bank's economic outlook since July – and the economic data have been on a roller-coaster ride in the intervening period. The question is whether the economy has emerged from the turbulent summer still on the course that the bank had envisioned.
There certainly won't be much drama in the rate decision itself. The Bank of Canada is almost universally expected to leave its key interest rate unchanged at 0.5 per cent, where it has sat since July, 2015 – which would mark the 10th consecutive rate decision in which the central bank stood pat on rates.
The bond market is pricing in no chance of a rate increase in this announcement, and only a 2.5-per-cent probability of a rate cut.
But the economic outlook is considerably less certain. While the economy's second-quarter swoon has turned out to be temporary – as the Bank of Canada predicted back in July – there remain plenty of unanswered questions about the staying power of the recovery beyond the third quarter. And it's unclear how confident the central bank is in Canada's growth path from here.
The bank itself expressed doubts when it last issued a rate announcement, in early September. It suggested that the second-quarter stumbles might have left "the profile for economic activity … somewhat lower than anticipated in July," and acknowledged that the risks to its inflation outlook – and, by extension, to interest rates, since the bank sets rates based on an inflation target – had "tilted somewhat to the downside."
At the time, observers couldn't help but wonder whether the bank was opening the door for a possible rate cut, particularly in light of the lack of traction in the export market – a part of the second-quarter slump that couldn't be explained away by the temporary impact of last spring's Alberta wildfires. The cautious tone helped push the Canadian dollar down by nearly two cents (U.S.) since the September rate announcement – a development that, conveniently, adds stimulus to the export sector, even if the central bank insists it doesn't use rate policy to steer the currency.
But since that September announcement, Canada's economic news has been decidedly upbeat. Exports posted their third consecutive monthly gain in August. Statistics Canada's Labour Force Survey estimated that employment surged by 67,000 jobs in September, the biggest one-month increase in more than four years. Real gross domestic product, the benchmark for overall economic growth, jumped 0.5 per cent in July – which, together with June's 0.6-per-cent gain, represents the biggest two-month growth spurt in nearly five years.
The central bank's own quarterly Business Outlook Survey, released earlier this month, suggested that business conditions may have turned a corner. Businesses in the energy sector indicated that they believe their downturn from the oil slump has finally bottomed. Overall investment and hiring intentions have turned upward, with signs that the slide in both among resource companies has abated. The business survey has typically carried considerable weight with the central bank's decision-makers during Governor Stephen Poloz's tenure, and its cautiously optimistic tone could help improve the bank's mood.
"Recent developments make it harder for the central bank to maintain its negative tone," National Bank Financial's economics team wrote in a report.
However, many economists think the bank still has good reason to retain the cautious language it adopted in September. Despite the recent positive indicators, the bank's economic forecasts from July look rose-coloured in light of the second-quarter backslide, an inconsistent U.S. recovery and a sputtering global growth outlook.
Among the economists at Canada's big banks, the median GDP growth forecast for 2016 is now 1.2 per cent, slightly below the 1.3 per cent the Bank of Canada projected in July. More notable, though, is the gap for 2017: a median of 1.8 per cent from the big bank economists, versus 2.2 per cent in the Bank of Canada's July projections.
If the Bank of Canada ratchets back its 2017 forecast, that could have considerable implications for interest-rate expectations. As it stands, economists anticipate that the bank will start raising rates about a year from now, as growth should be sufficient to close the output gap – the difference between what the economy produces and what it's capable of producing – by late next year. But a slower growth trajectory, coupled with the second-quarter setback, could push that timing back to early 2018.
"The Bank of Canada will lean on the dovish side, in sympathy with a slight downward revision to its growth outlook," predicted Canadian Imperial Bank of Commerce chief economist Avery Shenfeld.