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Jan 9, 2019

Bank of Canada holds steady as oil slump kills urgency for hike path

Bank of Canada holds key rate amid oil slump

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The Bank of Canada indicated less urgency in its push toward higher interest rates as the economy grapples with slumping oil prices.

The Ottawa-based central bank left its overnight benchmark rate unchanged at 1.75 per cent for a second straight decision Wednesday, citing a temporary slowdown that will create a modest amount of excess capacity and curb inflationary pressures. Weaker-than-expected consumption and housing activity also suggests the five hikes since mid-2017 may be having a stronger impact than expected, policy makers said.

The marking down of the near-term economic outlook highlights how difficult it will be for Governor Stephen Poloz to continue his hiking path with one of the country’s key industries in crisis, particularly given how fragile global financial markets have been.

“The Bank of Canada has taken itself out of the rate hike game, and its message today suggests that it isn’t quite as sure about when it will come off the sidelines and hike again,” Avery Shenfeld, chief economist at CIBC Capital Markets, said in a note to investors.

Where’s Neutral?

The central bank, though, is sticking to the view that multiple hikes will probably be needed to get to the “neutral range,” which officials estimate is between 2.5 per cent and 3.5 per cent. At a press conference after the rate decision, Poloz emphasized the economy remains on solid footing and has been operating at full capacity for more than a year, despite recent headwinds.

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And while acknowledging there remains plenty of uncertainty about where exactly neutral is, it’s unlikely to be below the central bank’s inflation target of about 2 per cent.

“It is natural to focus on the latest fluctuations in the economic data,” Poloz said in his opening remarks at the briefing. “But Governing Council also spent a good deal of time reviewing our starting situation to ensure that these new developments are put into appropriate context.”

The Canadian dollar and two-year bond yields were trading higher after the announcement, helped by a jump in global oil prices. The Canadian dollar appreciated 0.4 per cent to $1.3226 per U.S. dollar at 12:23 p.m. in Toronto trading. Yields on two-year government bonds were up 2 basis points to 1.92 per cent.

Economists expect hikes to resume later this year, most likely one or two more increases. Markets, however, are less sanguine, with swaps trading suggesting the Bank of Canada’s normalization may already have come to an end.

While reiterating in their rate statement that borrowing costs will need to rise, policy makers also added the words “over time” to the forward-looking sentence -- potentially indicating their intention for a short- term pause.

The central bank “continues to judge that the policy interest rate will need to rise over time into a neutral range to achieve the inflation target,” they said in the statement.

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The appropriate pace of rate increases “will depend on how the outlook evolves, with a particular focus on developments in oil markets, the Canadian housing market, and global trade policy,” it said.

The Bank of Canada estimated the recent slide in oil prices will reduce the level of Canadian output 0.5 per cent by 2020. It also cut its outlook for consumption and housing, citing a cocktail of developments that includes tighter provincial and municipal regulations, higher rates and tougher mortgage guidelines.

Growth is now forecast to be an annualized 1.3 per cent in the final three months of 2018, down from an October estimate of 2.3 per cent. The economy will slow further in the first quarter of this year, to an annualized pace of 0.8 per cent.

For the full year, the central bank estimates annual growth in 2019 of 1.7 per cent, down from its previous estimate of 2.1 per cent. That’s below the estimate for potential growth of 1.9 per cent, which means slack could increase.

The inflation outlook has also been revised lower to reflect the drop in gasoline prices, which central bank officials expect will be temporary.

At the same time, policy makers revised their forecasts for 2020 higher, as the economy rebounds on higher business investment and exports.

In fact, central bank officials seemed to go out of their way -- throughout the monetary policy report that accompanies the rate statement -- to highlight how the slowdown is largely limited to oil producing regions of the country.

“These developments are occurring in the context of a Canadian economy that has been performing well overall,” the central bank said in the statement.

 

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