Interest Rates

Bank of Canada halts rate hikes because of economic uncertainty

By: Jessica Mach on January 9, 2019

The Bank of Canada’s (BoC) first rate announcement of the year brings with it no new changes: the central bank will be keeping its overnight interest rate at 1.75%, where it has sat since October.

The BoC’s decision Wednesday was based on concerns about low oil prices, the U.S.-China trade conflict and “dampened” household spending, as well as fewer investments in the housing sector and slower Gross Domestic Product (GDP) growth than expected.

It marks a turn around from sentiment back in October, when it was widely expected the central bank would embark on multiple interest rate hikes in the new year.

The decision not to hike was expected. The U.S. stock market closed out 2018 with what the Associated Press called “its worst showing in a decade,” and the Canadian dollar entered 2019 on a weak note, with the loonie commanding only 73.30 cents (U.S.) — a drop of 6.41 cents on the year.

Signs of economic weakness

The BoC announcement also comes a week after the government of Alberta effectively cut oil production in the province by 8.7% (or 350,000 barrels a day), which Premier Rachel Notley ordered back in December to help push up falling oil prices. While the BoC writes that the cuts have already been effective, it maintains that “investment in Canada’s oil sector is projected to weaken further.”

The cuts are widely expected to reduce Canada’s GDP growth.

With these less than stellar developments unfolding over the new year, most experts had predicted that the BoC would not hike its overnight rate in January.

“The fact that the Bank of Canada will not be raising administered rates today will be the least exciting development,” Ian Pollock, the Canadian Bank of Commerce’s head of North American rates strategy, wrote a few hours before the announcement dropped. “Rather, the reaction by financial markets will be entirely predicated on how the Bank chooses to characterize economic conditions, particularly their view on the output gap given the move in energy prices.”

The BoC expects the output gap to widen in the first quarter due to low oil prices and a slowing economy (the output gap is the difference between how much the economy is producing, and what it is capable of).

The tone has changed in recent months

Still, the lack of a rate hike Wednesday will no doubt catch some economists off guard. As the first week of January saw the Canadian dollar strengthen and oil prices begin to climb, others were not so sure that the BoC would keep things the way they were — especially since the central bank had said as recently as December that it was still set on achieving its inflation target. To achieve this target, it would have to raise its overnight rate by at least another 75 basis points, to reach a “neutral range” of 2.5% to 3.5%.

“I think there are people thinking that the bank will stick to its guns a little bit, at least in terms of eventually getting back to neutral, and if so that should be supportive of the currency,” said Mark Chandler of RBC Capital Markets.

Nonetheless, the BoC framed the Canadian economy as one that was, on the whole, doing well.

“Growth has been running close to potential, employment growth has been strong and unemployment is at a 40-year low. Looking ahead, exports and non-energy investment are projected to grow solidly, supported by foreign demand, the CUSMA, the lower Canadian dollar, and federal tax measures targeted at investment.”

When's the next hike? 

So, can we expect a hike in the near future? The BoC expects the low value of the Canadian dollar to “exert some upward pressure on inflation,” but overall, the tone of the bank’s announcement is cautious.

“The appropriate pace of rate increases will depend on how the outlook evolves, with a particular focus on developments in oil markets, the Canadian housing market, and global trade policy,” the announcement reads. 

 

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