Interest Rates

Bank of Canada holds rates as it says economy has improved, but trade war risks grow

By: Lisa Coxon on May 29, 2019

The Bank of Canada (BoC) says that its prediction that a slowdown in the Canadian economy earlier this year would be temporary appears to be right as it maintained its target for the overnight rate at 1.75%.

The central bank was cautiously optimistic in its third announcement of the year, which was briefer than usual.

“Overall, recent data have reinforced Governing Council’s view that the slowdown in late 2018 and early 2019 was temporary, although global trade risks have increased,” the bank said. “In this context, the degree of accommodation being provided by the current policy interest rate remains appropriate.”

The last time the bank moved on rates was in October 2018.

Compared with the BoC’s last announcement, on April 24, which warned of a weak economic outlook, uncertainty around trade conflicts, and thus called for an “accommodative policy interest rate,” today’s brief announcement indicates the bank is happy keeping the overnight rate in this safe spot.

The decision to hold rates a fifth consecutive meeting will come as no surprise to experts. In a Reuters poll last Friday, 40 economists unanimously indicated that they expected the central bank to hold rates today. And looking ahead to the end of 2020, about two-thirds of the group predicted the central bank will either continue its hold until then, or announce a cut.

Holding … for now

The bank has been in a holding pattern since late last year, having previously expressed concern over the ongoing U.S.-China trade war, economic uncertainty, sluggish oil prices, dampened consumer spending due to high household debt, and — for the first time ever — climate change, which it cited as a key threat to the Canadian economy in its May 2019 Financial System Review (FSR).

On Wednesday, it made clear that the U.S.-China trade conflict is one of the biggest risks to its forecast.

“The global economy is also evolving largely as expected since April, although the recent escalation of trade conflicts is heightening uncertainty about economic prospects,” the bank said. “In addition, trade restrictions introduced by China are having direct effects on Canadian exports.”

But there are plenty of bright spots, as well. Oil prices have seen a bit of a resurgence recently. According to Statistics Canada, oil and gas companies saw operating profits rise by $1.6 billion in the first three months of this year due to a rise in oil prices. This is after oil stocks fell 5% last week amid fears of a worsening trade situation and after oil and gas operating profits dropped by $678 million in the fourth quarter of 2018.

The bank noted in today’s announcement that this sector is “beginning to recover” with increases in production and price.

The trade war has also shown a glimmer of improvement, with Canada and the U.S. agreeing to lift tariffs on aluminum and steel — a development that’s provided some assurance for the bank.

“... the removal of steel and aluminum tariffs and increasing prospects for the ratification of CUSMA will have positive implications for Canadian exports and investment,” the bank said in its announcement.

In April, the bank said it expected economic growth to pick up starting in the second quarter of this year. In today’s announcement, it confirmed that this projection has indeed held true.

“Recent Canadian economic data are in line with the projections in the Bank’s April Monetary Policy Report (MPR), with accumulating evidence that the slowdown in late 2018 and early 2019 is being followed by a pickup starting in the second quarter.”

In its April announcement, the bank said that it predicted Canada’s GDP would grow by just 1.2% this year and around 2% in 2020. The bank did not make any predictions surrounding GDP in today’s announcement. But it did say that it expects CPI inflation to remain around the 2% mark.

In its May FSR, the bank expressed concern about a nationwide recession, a housing market correction, and “fragile corporate debt funding,” which it said poses a risk to the country’s financial system.

Today, the bank said that the housing market has appeared to stabilize, though there is still some weakness in certain regions. And while the mortgage stress test might be helping to keep those markets cool, the debate around whether to ease restrictions has gotten heated. Groups like the IMF and the head of the CMHC have now started chiming in, arguing that it would be far from prudent to loosen the rules at this time.

The bank also said there’s been a “pickup” in consumer spending, and that business growth has improved.

Is a rate cut on the table?

The bank didn’t allude to the possibility of future cuts, but it’s evident from its “accommodative” language that it’s in no hurry to hike, either.

“Overall, the statement doesn't explicitly warn of rate hikes to come (that remains data dependent),” Avery Shenfeld of CIBC wrote in a note after this morning’s announcement, “but has an optimistic tone about what lies ahead, leaving the impression that the Bank sees the next move as a hike, if well down the road.”

One economist believes the ongoing trade troubles between the U.S. and China could, however, inspire the bank to cut.

“If they (the BoC) cut, it is more likely to be on global weakness – generated by U.S.-China tensions most likely – than weakness specifically in Canada,” David Sloan, senior economist at Continuum Economics, told the Financial Post last week.

But there is one promising economic development that could warrant a more hopeful outlook: a strong labour market.

Record-breaking job gains were made last month, with 106,500 jobs gained in April alone — the largest one-month employment gain since jobs data started being collected in 1976. This caused the unemployment rate to drop from 5.8% to 5.7% and marks a significant pickup after job numbers dipped by 7,200 in March.

“Continued strong job growth suggests that businesses see the weakness in the past two quarters as temporary,” the bank said.

A smaller sample of economists polled in the Reuters survey last Friday are still putting the possibility of a rate cut before the end of 2020 at 40%. And some analysts aren’t expecting the bank to move on rates — up or down — until after the federal election in October.

Going forward, the bank will be keeping an eye on the same areas it cautioned about in last month’s announcement.

“In taking future policy decisions, Governing Council will remain data dependent and especially attentive to developments in household spending, oil markets and the global trade environment.”

The next scheduled overnight rate announcement will be held on July 10, which will include the bank’s next Monetary Policy Report as well.