BoC: Poloz Holds for Today with an Unchanged Message

BoC: Poloz Holds for Today with an Unchanged Message

As was widely expected, the Bank of Canada held its key monetary policy interest rate at 1.25%.

The Bank simultaneously released its latest Monetary Policy Report (MPR), providing an update on how the Bank sees the economy evolving. In the event, the growth outlook for this year was revised down slightly, to 2% (from 2.2%). This appears to largely reflect the soft start to the year, which is expected to give way to healthy growth in the second quarter. In contrast, the 2019 forecast saw a marked upgrade, from 1.6% to 2.1% on a stronger consumption outlook and slower imports. Newly included, a 1.8% growth pace is seen for 2020, in line with the economy’s (upwardly revised) trend.

On that front, perhaps the most notable part of today’s communications is a sizeable change to the Bank’s view of potential (or trend) real GDP growth. The range for 2017-2019 has been raised by roughly 0.4 percentage points. As a result, the Bank now sees the economy as having almost, but not quite reached its potential, rather than being at or slightly above it at the end of last year.

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Most standard frameworks suggest that with more slack comes less inflationary pressure, and this appears to be the case for the Bank. Recent inflationary pressures are seen as partially temporary, owing to minimum wage increases and other transitory effects. Inflation is expected to moderate to just above the 2% target in 2019 and 2020 as these effects diminish.

A key focus for the Bank of Canada has been assessing labour market slack. The MPR notes improving conditions, but areas of concern remain: youth labour market participation is still seen as soft, while long-term unemployment is seen as elevated. All told, the Bank maintains a constructive outlook for labour markets, and has provided something of a benchmark: 3% growth in wages are seen as consistent with no labour market slack. For reference, their preferred measure, ‘Wage-common’, read 2.7% in 2017Q4, the most recent data available.

The MPR also provided an update to the key economic risks as seen by the Bank of Canada. First on the list is weaker investment and exports, a reflection of both recent soft trade data and uncertainty around NAFTA and the global trading system more generally. The second risk was also to the downside, with a sharp tightening in global financial conditions possible. Rounding out the risks were the possibility of stronger U.S. GDP growth (upside), stronger consumption (and debt growth) here in Canada (near-term upside), and a pronounced decline in Canadian home prices (downside).

Key Implications

The core message sent today appears to be that Poloz and company remain set on further hikes, but are in no rush to get there. The statement accompanying the decision may have had a hint of hawkishness to it, but the details of the Monetary Policy Report were decidedly dovish.

Indeed, with the Banks assessment of the economy’s ‘cruising speed’ getting a sizeable upgrade (and economic ‘tightness’ getting a downgrade by extension), it is no surprise that the Bank sees only modest underlying inflationary pressures. Moreover, the Bank continues to see pockets of weakness in labour markets, and while recent developments have been promising, NAFTA negotiations and trade developments more generally remain a cloud over the forecast.

As a result, despite many moving pieces, the outlook for rates remains effectively unchanged. More hikes are coming, with this summer remaining the likely target for the next move, but the path is by no means set. Labour market developments (particularly wages), core inflation measures, and the evolution of business investment are likely to be the key domestic metrics influencing the timing of the next hike.

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