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‘The Question is When’: How Bank of Canada Rate Expectations Are Changing

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Expectations are mounting the Bank of Canada will be forced to cut interest rates and join a growing number of central banks that have eased monetary policy as the U.S.-China trade war intensifies and recession signals ripple through financial markets.

The bank’s key rate has been locked at 1.75 per cent since October, 2018, and a recent bout of strong economic data has given Governor Stephen Poloz and his colleagues little reason to move.

But the Bank of Canada finds itself increasingly isolated. At least 23 central banks have cut their key rates in 2019, according to Bloomberg data, including the U.S. Federal Reserve last week. Three of them – in New Zealand, India and Thailand – did so on Wednesday, and more easing appears imminent.

On top of that, U.S. President Donald Trump has ratcheted up the trade war, saying the United States would impose a 10-per-cent tariff on an additional US$300-billion of Chinese imports, raising fears for the global economy’s outlook.

“If you’re asking yourself if [the Bank of Canada will cut], it’s the wrong question,” said Ian Pollick, head of North American rates strategy at CIBC Capital Markets. “The question is when.”

Given trade concerns, CIBC has moved up its projection for a rate cut to the first quarter of 2020 from the second quarter.

Investors have set a more aggressive timeline. Futures tied to the Bank of Canada’s overnight lending rate imply a 60-per-cent chance the central bank will cut in December. A month ago, those odds were 10 per cent.

Even more aggressive is Capital Economics. The research firm expects the first of three Bank of Canada rate cuts to land in October, with the benchmark rate declining to 1 per cent by early 2020.

“The Bank’s forecasts are not as strong as other people seem to be suggesting they are, and … the downside risks really are mounting now,” said Stephen Brown, senior Canada economist at Capital Economics.

Much of the downside is coming from abroad. In addition to trade concerns, a variety of weak economic data has spilled out in recent weeks, including mediocre manufacturing figures out of Europe. This has raised concerns the global economy is ripe for a sizable slowdown.

By comparison, Canada has been a beacon of strength. Economic data have been strong in the second quarter, and growth is trending toward a 3-per-cent annualized expansion in that period.

On two of the Bank of Canada’s big concerns – inflation and jobs – the returns are likewise solid. Some inflation measures are tracking above the bank’s 2-per-cent target, and hiring has been robust in 2019, with close to 250,000 jobs added through the first half of the year. In percentage terms, it has been the strongest start to a year for job creation since 2010.

The next Labour Force Survey is released Friday, and the consensus estimate calls for 15,000 jobs added in July, with the jobless rate holding at 5.5 per cent.

Because of this strong run, the Bank of Canada has a “hall pass” to stand by and see how macroeconomic conditions develop, Mr. Pollick said.

But, he added, if global uncertainty weighs on domestic sentiment and affects business spending, “then from a purely risk-management perspective, you need to do something to add more stimulus to the economy ….”

Not everyone thinks the Bank of Canada will move. Sal Guatieri, senior economist at BMO Nesbitt Burns, expects it to hold steady, noting its benchmark rate is negative in real terms (that is, after accounting for inflation) and that the jobless rate suggests full employment.

“The Bank must also be wary of fanning the embers of a warming housing market and more sustainable household credit growth. Patience seems warranted,” Mr. Guatieri wrote in a client note.

“However, if the trade war takes a bigger toll on the global economy and oil prices, the Bank will likely be forced to take out some insurance of its own.”

There is also the possibility that Mr. Poloz could surprise, Mr. Brown of Capital Economics said. In January, 2015, Mr. Poloz shocked markets by cutting rates for the first of two times that year, in response to an oil-price collapse that threw Alberta into recession.

“The Bank has a history of surprising, and when it comes to monetary policy, the old adage is, ‘You should shock on the way down and sign-post everything on the way up,’” Mr. Brown said.

Article courtesy of the Globe & Mail, Outline Financial and FSB as originally posted in the Globe and Mail.