Blog – Bank of Canada Sets a Tough Stage for Justin

October 21, 2015

There were a few reasons not to expect the Bank of Canada today to do anything with rates. The rebound in economic activity in the third quarter and now a Liberal majority platform that calls for significant fiscal stimulus were just two of them. So no surprise that Mr. Poloz and crew did not cut rates this morning. In return the Bank did raise the bar for the Liberals to jump over as it cut its economic forecast for 2016 to 2% from 2.3%, which comes mainly from a downward revision to this quarter’s growth to 1.5% from 2.5%. Considering the technical recession in the first half of this year and a recovery in oil prices which stalled out yet again around $50/barrel, the less optimistic tone in today’s policy statement was not a surprise either. In particular the Bank now sees a 20% drop in investment spending by energy firms next year which will counter some of the other positive expectations in 2016. These would include a more robust US economy and an export boost from a more competitive Canadian dollar. Note, the Bank also sees zero growth contribution from Canada’s housing sector in 2016 and 2017 and this might turn out to be optimistic if higher bond yields translate into rising mortgage rates next year. What is missing in the new Bank of Canada forecasts, however, is fiscal stimulus and this might be the one thing that skates the predictions on side.

In terms of the outlook for interest rates the Bank is expected to remain on the sidelines while it assesses global developments in the fourth quarter, as well as the direction of oil prices. Add to that watch list the upcoming budget. The Bank did comment in its Monetary Policy Report that excess capacity in Canada’s economy has widened this year, which leaves the window open for one more rate cut in December. In my opinion, the Bank won’t go down that path given the still spin on 2016 economic activity and the fact that the federal government will shoulder more of the burden in terms of fiscal stimulus. With US rate hikes just around the corner makes the argument for standing pat on rates even stronger. Currency traders and the bond market took this morning’s statement and policy report to be ‘dovish’, selling off the Loonie and sending bond yields lower. I think both of those moves could get reversed fairly soon.