The Bank of Canada Holds Rates Steady, But for How Long?

When the Bank of Canada (BoC) met last week, it left its overnight rate unchanged at 1.5% as was widely expected. The real question for anyone keeping an eye on Canadian mortgage rates was whether the Bank would hint at its plans for its next meeting on October 24.

The futures market is currently assigning about an 80% probability that it will raise by another .25% next month. In the past, the Bank would often use language that effectively warned the market if another hike was imminent. But in a recent speech, BoC Governor Poloz conceded that the Bank is currently navigating through a period of heightened uncertainty that is diminishing its ability to offer forward guidance and that it would rely more heavily than normal on our fast-moving stream of incoming data when determining its future policy-rate path.

With that in mind, in today’s post I’ll provide the highlights for the BoC’s latest statement, but more importantly, I’ll summarize what the key recent data are indicating about our economic momentum. (Spoiler alert: If the Bank really is now extremely data dependent, I don’t think it will raise rates next month.)

Five Highlights from the BoC’s Latest Statement

• The BoC acknowledged that our recent inflation data had come in “higher than expected” but it attributed this to a temporary spike in airfare costs and predicted that the inflation rate would move “back towards 2 per cent in early 2019 as the effects of past increases in gasoline prices dissipate”.
• The Bank observed that overall global growth has been consistent with its most recent projections and that “the U.S. economy is particularly robust, with strong consumer spending and business investment”. That said, the BoC also acknowledged that “elevated trade tensions remain a key risk” for the global outlook and that “financial stresses have intensified in certain emerging market economies”.
• The BoC assessed that the Canadian economy is evolving “closely in line” with its most recent projections, with slow first quarter GDP growth of 1.4% being followed by a strong rebound to 2.9% in the second quarter. The Bank expects our GDP growth to slow again in the third quarter “mainly because of fluctuation in energy production and exports”.
• The BoC expressed confidence that the economy’s rotation toward business investments and exports was evolving as hoped. It observed that “business investment and exports have been growing solidly for several quarters”, that “activity in the housing market is beginning to stabilize“, and that “continuing gains in employment and labour income are helping to support consumption”. Encouragingly for our policy makers, the BoC also noted that “credit growth has moderated and that household debt-to-income ratio is beginning to edge down”.
• In its key closing statement, the BoC reiterated its belief that “higher interest rates will be warranted over time” but once again emphasized that it would “take a gradual approach, guided by the incoming data”. More specifically the Bank said that it would focus on “the economy’s reaction to higher interest rates”, and that it would closely monitor “the course of the NAFTA negotiations and other trade policy developments”.

In summary, BoC’s latest statement confirmed that it is still leaning toward additional rate increases, but the more important detail for anyone with a variable-rate mortgage is the timing of when these increases will occur. To answer that question, let’s look at our most recent economic data, which will guide the Bank’s actions:

• Our GDP grew by 2.9% over the second quarter but it came in flat for June on a month-over-month basis. That means that our economic momentum had already stalled out as we entered the third quarter.
• Consumer spending increased by 2.6% on an annualized basis in the second quarter, up from 1% in the first quarter of the year. But economist David Rosenberg noted that our savings rate fell from 3.9% to 3.4% over the same period and he calculates that without that saving drawdown, “real consumer spending would have been sub-1% and real GDP growth would have been sub-2%”.
• Last week Statistics Canada confirmed that our economy lost an estimated 52,000 jobs in August. Last month’s losses mean that we haven’t added a single net new job thus far in 2018. Over that same period, the total number of private-sector jobs has decreased while the total number of tax-payer funded public-sector jobs has increased, and that trend is unsustainable. Meanwhile average year-over-year wage growth came in at a decent 2.9% in August, but that was down from 3.2% in July, which was down from 3.6% in June. Here again, we see slowing momentum.
• Our rate of household debt accumulation has also slowed sharply of late. That will come as welcome news to the BoC, but it also provides cause for pause because it means less consumer spending. The Bank has repeatedly predicted that our elevated household debt levels will magnify the impact of additional rate hikes, and it has estimated that it can take up to two years for the impact of each incremental raise to fully work its way into our economy. Given that, near-term caution is certainly warranted.
• Our Consumer Price Index (CPI) hit 3% in July, but the BoC’s three key sub-measures of core inflation are all still hovering in a tight 2% range. The Bank is predicting that the temporary factors that have led the CPI higher of late will dissipate naturally by early 2019, and more importantly, it believes that the recent run up is not being caused by excess demand. That doesn’t guarantee the Bank won’t raise rates in the meantime, but it does imply that there is less urgency to do so if other factors call for restraint.

Finally, the elephant in the room remains our negotiations with the elephant on our southern border. Some observers believe that a resolution to the NAFTA talks would clear the way for the BoC to raise rates more aggressively but I agree with the CIBC Chief Economist Avery Shenfeld’s recent observation that the BoC “will still have to be careful about hiking at a pace that takes the loonie to further levels, given its desire to rotate growth towards exports [and away] from consumption and housing”.

The Bottom Line: While the BoC still believes that “higher interest rates will be warranted to achieve the inflation target”, if it is relying heavily on the incoming economic data to determine the timing, I don’t think the Bank will raise at its next meeting on October 24.