Interest Rates

Chance of interest rate cut rises as Bank of Canada turns more dovish

By: Jessica Mach on April 24, 2019

The Bank of Canada (BoC) announced Wednesday that it will keep its overnight interest rate at 1.75% while warning that the economic outlook has materially weakened since January.

This is the fourth consecutive rate hold by the BoC. The central bank’s overnight rate has not moved since October, when it increased by 25 basis points.

The bank has recently walked back strong language suggesting interest rates need to rise as Canada’s economy has slowed this year, a stark contrast with the stance that the BoC has held since 2017, when it raised its overnight rate for the first time since 2010 and proceeded to hike rates four more times over the next year and a half.

“Governing Council judges that an accommodative policy interest rate continues to be warranted,” the announcement reads.

Wednesday’s release also included the bank’s Monetary Policy Report, an annual update on the economic environment affecting its decisions. In it, the bank says it now sees Canada’s GDP growing by only 1.2% in 2019, versus its 1.7% prediction earlier this year. The bank expects a rebound to 2% next year.

That growth reading would be one of the weakest since 2015, when oil prices crashed and the BoC was forced to cut interest rates back to near-zero.
 

Weak Canadian economy behind shift in tone

Wednesday’s decision follows a series of economic developments that made it hard to justify a hike anytime soon.

Morale among business owners is clearly low. The Business Outlook Survey, which measures how Canadian businesses feel about the economy, reported a negative outlook for the first time in three years. Uncertainty about global trade issues — especially tensions between China and the U.S. — accounted for respondents’ dampened outlook, as did lowered expectations for how U.S. growth would benefit them.

“Ongoing uncertainty related to trade conflicts has undermined business sentiment and activity, contributing to a synchronous slowdown across many countries,” said the BoC.

The bank says it now expects this trade uncertainty to reduce the level of business investment by 2.5% by the end of 2021, whereas before it had expected a 1.8% decrease.

“Whereas businesses were previously worried about being able to meet demand and fill vacant positions, they are now much less concerned about capacity pressures,” wrote mortgage broker David Larock. “They are now cutting prices instead of raising them.”

On Tuesday, the Canadian dollar fell to a nearly four-week low, trading in the afternoon at 1.3436 to 74.43 U.S. cents. The 0.7% drop was the loonie’s biggest decline in almost seven weeks.
 

Some green shoots for economy

The Canadian economy did see a few improvements, however, mostly due to ongoing global conflict. On Monday, the Trump administration announced that it would impose trade sanctions on several countries, including U.S. allies, if they continue to buy Iranian oil. The move effectively re-directed consumers to Canadian oil, driving domestic prices up.

The BoC expects the Canadian economy will continue to see improvements starting in the second quarter of this year. “Housing activity is expected to stabilize given continued population gains, the fading effects of past housing policy changes, and improved global financial conditions,” said the announcement.

“Consumption will be underpinned by strong growth in employment income. Outside of the oil and gas sector, investment will be supported by high rates of capacity utilization and exports will expand with strengthening global demand.”
 

Could the next move back a rate cut?

Wednesday’s announcement clearly signals the bank has no intention to raise rates this year — it would surprise the market after such a cautious release.

Some experts predict the next move will be a rate cut, including David Rosenberg, the famously bearish economist, as well as economists at TD and Capital Economics.

However, while this year may see no move or even a rate cut should a negative shock come along, the BoC also says it expects economic growth to return and that the current malaise is temporary.

The bank says it sees non-energy investments rebounding in the second half, that services exports will continue growing at a strong pace and that travel services, including tuition paid by international students, will be important contributors to growth. All of this still leaves the possibility of a return to rate hikes next year. 

 

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