Yet again, it’s no surprise that the Bank of Canada (BoC) maintained its target overnight rate at 0.5% today, Wednesday, January 18, 2017. The Bank of Canada is reaffirming its view that the Canadian economy is still operating with considerable slack despite strong employment growth and inflation remains below the 2% target rate. One of the key pieces to highlight from today’s announcement is that “uncertainty about the global outlook is undiminished, particularly with respect to policies in the United States.”
President Trump’s inauguration just two days away signifies major policy changes, some of which could have a direct impact on Canada.
US Growth Revisions
For now, the Bank of Canada has chosen to incorporate assumptions about prospective tax policies only, resulting in a modest upward revision to its US growth outlook. US growth in 2017 was revised up only slightly, from 2.1% to 2.2%. The impact of the new administration’s fiscal stimulus is more pronounced in 2018, increasing the Bank’s forecast to 2.3% (up 0.3 percentage points from the October forecast). These are initial estimates, which include changes in tax policies only. Clearly, an important factor impacting Canada will be US trade policy. The impact of this and other fiscal measures will be updated in future BoC reports as more details become available.
The BoC’s forecast for US growth is above its estimate of the rate of potential US output expansion of about 1.8% in 2018. The economy is judged to be already at or near full capacity. Business investment in the US is expected to regain momentum as growth in demand remains above potential output.
Canadian Growth
The BoC believes that growth in the Canadian resource-related sectors have troughed and investment and employment are being reallocated to the growing service sector. Real GDP in Canada is expected to grow at a rate moderately above potential output as housing slows. The bank is estimating that housing boosted growth in 2015 and 2016 by 0.3% and 0.2% respectively. Housing will be a small net drain on activity this year, according to the MPR, reflecting the negative impact of tighter mortgage restrictions and the rise in mortgage rates
Will the Bank of Canada Cut Interest Rates?
Some have suggested that the Bank of Canada might cut interest rates again next year, particularly if housing slows too much. Judging from comments made by the CEO of the CMHC, a slowdown in housing is the intended result of the new rules. Clearly, Governor Poloz sees the enhanced mortgage stress tests and changes in the insurability of mortgages as mitigating his concerns of overextended homebuyers. It would take a material negative shock to growth for the BoC to cut rates.
On the other hand, others recently have suggested the Canadian economy will benefit sufficiently from the fiscal boom in the US for the Bank to hike rates by the end of this year. This is unlikely as market rates have already risen and the potential negative impact of a stronger Canadian dollar on trade, as well as a potential US harder line on trade–such as recent US saber rattling on a border tax–will keep the Bank of Canada on the sidelines through the rest of this year.
The next scheduled date for announcing the overnight rate target is Wednesday, March 1, 2017.
Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres “Bank of Canada on Hold as Expected”, accessed January 18, 2016, https://www.dominionlending.ca/news/bank-canada-hold-expected/
