Interest Rates

Bank of Canada keeps close eye on escalating trade conflict as it holds overnight interest rate

By: Lisa Coxon on September 4, 2019

Keep calm and hold on. That appears to be the motto of the Bank of Canada this morning, as it maintained its overnight interest rate at 1.75%, continuing an almost year-long pause on rate hikes.

Though the central bank didn’t hint at the need for a near-future cut, it did take a wary and cautious tone in its sixth announcement of the year, acknowledging the escalating trade tensions between the U.S. and China, “unexpectedly soft” consumer spending in the second quarter and business investment that “contracted sharply after a strong first quarter.”

Still, the bank says its current policy is appropriate for the current circumstances.

Inflation is on target at 2%. “CPI inflation in July was stronger than expected, largely because of temporary factors,” the bank said. “These include higher prices for air travel, mobile phones, and some food items, which are offsetting the effects of lower gasoline prices.”

The results of today’s rate announcement were, for many economists, a bit of a toss up. A surprise cut was very much possible, given the global downward trend in interest rates we’re seeing from countries like the United States and Mexico, and the sustained trade war between the U.S. and China. 

But chances of holding the rate steady crystallized as we headed into Labour Day weekend, when the country’s GDP showed a growth of 3.7%. BMO Canada’s rates and macro strategist, Benjamin Reitzes, said in a note that it was “widely expected” the bank would hold the overnight interest rate today at 1.75%. And the National Bank said there was “no need” to cut rates this year unless the trade conflict escalates.

Trade war top of mind

Trade tensions between the U.S. and China remain the top concern for the central bank as it decides whether or not to shift interest rates in the near future.

“Escalating trade conflicts and related uncertainty are taking a toll on the global and Canadian economies,” the bank said.

Since its last meeting on July 10, trade tensions have intensified, with a new round of tariffs implemented over Labour Day weekend and more slated to come before the end of the year. 

There are domestic concerns, too. Canada posted a $1.1 billion trade deficit in July, as exports fell and imports rose, according to Statistics Canada. That number is a significant increase from June, when the deficit was only $55 million.

Although the bank seemed relatively positive about the strength of Canada’s housing market, it also cautioned that recent heightened activity could exacerbate household debt levels.

“Housing activity has regained strength more quickly than expected as resales and housing starts catch up to underlying demand, supported by lower mortgage rates,” the bank said. “This could add to already-high household debt levels, although mortgage underwriting rules should help to contain the buildup of vulnerabilities.”

In some provinces, household debt levels remain a concern. Quebec, for instance, was slapped with higher minimum credit card payments in an effort to rein in household debt levels in the province. 

As for the labour market, Canada lost 24,000 jobs in July. But it’s not all bad: according to the Canadian Federation of Independent Business (CFIB), roughly 429,000 positions are still up for grabs in the private sector, which is more than the number of jobs that were available a year ago. Another bright spot in this market is that wages have picked up and boosted labour income, the bank said.

Cuts and contractions around the world

If the BoC had cut its overnight rate on Wednesday, many would have likely seen the move as jumping the gun. But a cut will probably have to happen in the near future, since interest rates are on a global downward trend. The U.S. Federal Reserve cut interest rates for the first time in a decade at the end of July. Mexico slashed its interest rates earlier this month for the first time in five years, after the country’s inflation slowed and its economy faltered. And we even saw Denmark’s Jyske Bank begin to offer consumers negative mortgage interest rates. 

Interest rates aren’t the only thing contracting, either. Germany’s economy contracted in the second quarter of this year, by 0.1%, as did the U.K.’s, by 0.2%.

The bank also called attention to the inverted yield curve, which happens when the value of short-term bonds start to be worth more than long-term bonds. It has traditionally been a clear indicator that a recession is on the horizon. 

No real hint at a domestic cut

The bank didn’t allude to the need for a cut in the near future. It might be holding steady for now and buying itself some time to monitor the effects of the trade war on the domestic economy, but economists don’t see Poloz finishing off the year without at least one rate cut.

Senior vice president and chief economist for Scotiabank, Jean-Francois Perrault, predicted in the bank’s August global economic forecast that the Bank of Canada will cut by 25 basis points at its October 30 meeting, and by another 25 points in the first quarter of 2020.

A Reuters poll taken last week indicated that economists believe we’ll see a cut at October’s announcement. BMO’s chief economist, Douglas Porter, said this would make the most sense since it’s the week after the Canadian federal election and the day before the U.K.’s deadline to exit the EU.

As Porter put it to the Globe and Mail, “The real debate will centre on the bank’s decision at the Oct. 30 meeting.”