Are You Buying the Hope That the Bank of Canada Is Selling?

The Bank of Canada (BoC) left its overnight rate unchanged last week, as was widely expected. Some market watchers had speculated that the Bank might actually cut its policy rate in response to the recent worsening in our economic data, but the BoC’s ongoing concerns about rising household imbalances make a near-term policy-rate drop unlikely in all but the most extreme circumstances (for the reasons I outlined in this recent post).

In its accompanying press statement, the Bank followed a familiar pattern, acknowledging that the current data are weak while expressing hope that momentum will soon turn in our favour.

Here are the highlights from the BoC’s latest statement with my comments included:

• Global growth in the first half of 2016 was “slower than expected” but the Bank expects that it will “strengthen gradually in the second half of this year”. This hopeful view was centred around the belief that a “healthy” U.S. labour market and “solid consumption” would support a rebound in U.S. growth in the second half of this year, even as “the outlook for business investment has become less certain”. In last week’s post, I explained why I don’t think that the U.S. labour market is as healthy as the headline numbers suggest, and why increased consumption that isn’t supported by rising incomes will only give the U.S. economy a boost that is akin to a short-term sugar high. Meanwhile, the Bank is less confident that business investment, which is the key missing ingredient in today’s global economic recovery, will rebound.
• “Global financial conditions have become even more accommodative since July.” What else is new? Global financial conditions have become steadily more accommodative for years now, and how has that worked out for everyone so far? Isn’t the definition of insanity doing the same thing over and over again and expecting a different result? Unfortunately, I fear this pattern of ever-loosening monetary policy will eventually produce a result that is different, but not in the way the world’s central bankers are hoping for.
• Second quarter Canadian GDP “was pulled down by the Alberta wildfires in May and by a drop in exports that was larger and more broad-based than expected”. The Alberta wildfires were a one-off event and we can therefore discount their negative short-term impacts on our economic data, but the drop in exports is of greater concern. The BoC noted that the export data disappointed “even after accounting for weaker business and residential investment in the United States, adjustments in the resource sector, and cutbacks in auto production.” That’s quite a grim acknowledgement for the sector of our economy that is most critical to our long-term economic trajectory.
• The BoC expects our economy to recover in the third quarter as “oil production recovers, rebuilding commences in Alberta, and consumer spending gets an additional lift from Canada Child Benefit payments”, and in the fourth quarter “as federal infrastructure spending starts to have more impact”. While all of these factors could well boost our short-term economic momentum, exports are the game changer, and on that note, the Bank acknowledged “that the ground lost over previous months raises the possibility that the profile for economic activity will be somewhat lower than anticipated in July.”
• The BoC observed that inflation risks “have tilted somewhat to the downside since July”, and falling inflation, over time, makes the Bank more likely to lower its overnight rate. Conversely, the BoC also noted that “financial vulnerabilities associated with household imbalances remain elevated and continue to rise”, and more rate cuts would exacerbate these imbalances. These competing forces are roughly offsetting and should ensure that the Bank’s overnight rate won’t be moved in either direction for the foreseeable future.

In its latest press statement, the BoC acknowledged that our recent economic data have disappointed, and frankly, with the numbers as they are, how could it do otherwise? Then, in an effort to mitigate our disappointment, the Bank cited a range of factors that should help our economic momentum improve in the second half of 2016. But let’s not kid ourselves. Our economic future will be determined by demand for our exports, and when all of the Bank’s references to our export momentum are negative, everything else is just window dressing.

Five-year Government of Canada bond yields rose two basis points last week, closing at 0.71% on Friday. Five-year fixed-rate mortgages are available in the 2.29% to 2.39% range, depending on the terms and conditions that are important to you, and five-year fixed-rate pre-approvals are offered at about 2.49%.

Five-year variable-rate mortgages are available in the prime minus 0.40% to prime minus 0.50% range, which translates into rates of 2.20% to 2.30% using today’s prime rate of 2.70%.

The Bottom Line: The latest BoC statement confirmed that the Bank remains cautious about our economic prospects, which makes it unlikely that it will hike rates any time soon. The Bank also repeated its concern about rising household imbalances, making it unlikely that it will drop rates instead. These opposing forces leave the Bank in a neutral position, wherein it acknowledges the weakness in the recent economic data and sells us the hope that economic growth, and not more policy-rate stimulus, will lead us to a brighter future. Are you buying it?