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Jul 10, 2019

Poloz flags growing trade risks but keeps rates firmly on hold

Tricky road ahead for the Bank of Canada: Economist Eric Lascelles


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Bank of Canada officials flagged elevated concerns about mounting global trade tensions, even as they left interest rates unchanged for a sixth straight decision and showed little willingness to consider easing policy any time soon.

In a decision Wednesday, policy makers reiterated the current policy rate -- at 1.75 per cent -- remains “appropriate.” They painted a picture of an improving Canadian economy, but one whose path back to full capacity is being slowed by an escalating trade conflict.

The net effect is a broadly neutral stance that suggests the Ottawa-based central bank remains on hold indefinitely, not in any rush to move interest rates in either direction. Still, the emphasis on trade risks is prompting questions about the central bank’s confidence in the country’s rebound.

The statement doesn’t “signal any particular rush to follow the Fed toward possible rate cuts,” Brett House, deputy chief economist at Bank of Nova Scotia, said by email. A weaker-than-expected growth projection, however, “provides some caution on the bank’s view on the durability of the rebound.”

Adding to the sense the Bank of Canada has moved marginally more dovish is Governor Stephen Poloz’s reluctance to talk about raising interest rates -- as he has in the past -- at a press conference after the decision.

“For now, as we’ve said today, the conditions that we observe are consistent with today’s setting of interest rate getting us to a steady inflation performance,” Poloz said when asked whether he still sees the likelihood of a rate hike as being greater than a cut.

The Canadian dollar pared earlier gains following the decision, but was still up 0.3 per cent to C$1.3091 per U.S. dollar. Canadian two-year bond yields were also down 5 basis points to 1.59 per cent, the biggest drop in almost a month. Odds of a rate cut also ticked up higher, though investors are still not fully pricing in move over the next 12 months.


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    Strong Data

    A strong run of economic data is affording the Bank of Canada opportunity to resist any dovish turn in global monetary policy. Market pricing suggests investors aren’t expecting Poloz to match cuts by the Federal Reserve over the next year. As a result, Canada may end up with the highest policy rate among advanced economies within the next 12 months.

    In testimony to U.S. lawmakers Wednesday, Fed Chairman Jerome Powell seems to have pushed the central bank closer to cutting interest rates this month by saying the economy continues to face downside risks including the U.S.-China trade war and sluggish inflation.

    After Canada’s expansion stalled at the end of last year, growth is returning to potential, with much of the newly created economic slack largely centered in energy producing regions, policy makers said. The immediate rebound has been stronger than expected, with the Bank of Canada revising up its growth projections for the second quarter to an annualized 2.3 per cent.

    At the same time, the central bank said some of the recent pick-up will be temporary, and growth will decelerate in the third quarter. The net effect is that growth for all of 2019 will remain sluggish at 1.3 per cent -- little changed from the 1.2 per cent expected in April when the Bank of Canada last released economic forecasts.

    Global trade tensions, meanwhile, have escalated, particularly between the U.S. and China, forcing policy makers to mark down their projections for global growth and lower estimates for business investment and exports. These include new Chinese trade restrictions on Canadian agricultural goods, the bank said.

    “Recent data show the Canadian economy is returning to potential growth. However, the outlook is clouded by persistent trade tensions,” the central bank said in its statement, reiterating it will continue to monitor incoming data. “Taken together, the degree of accommodation being provided by the current policy rate remains appropriate.”

    ‘Material Effect’

    Broader global trade tensions are driving down commodity prices and are outweighing some positive developments, such as the removal of U.S. tariffs on Canadian steel and aluminum. The impact of ongoing tensions is the first issue highlighted in the statement, and the Bank of Canada acknowledged that other central banks seem ready to provide additional stimulus in the face of slowing global growth.

    “Evidence has been accumulating that ongoing trade tensions are having a material effect on the global economic outlook,” the Bank of Canada said. “Trade conflicts between the U.S. and China, in particular, are curbing manufacturing activity and business investment and pushing down commodity prices.”

    Because of these trade tensions, the Canadian economy will grow slightly less than expected next year -- 1.9 per cent versus an initial estimate of 2.1 per cent. Exports account for all of the downward revision.

    --With assistance from Luke Kawa, Shelly Hagan and Chris Middleton.