The Bank of Canada left the overnight rate unchanged at 1.00% as expected. But the tone of the statement was quite dovish as the BoC acknowledged "material excess capacity in the economy". The Bank also acknowledged "more constructive evolution of imbalances in the household sector". Those support the relatively dovish concluding statement: "with continued slack in the Canadian economy, the muted outlook for inflation, and the more constructive evolution of imbalances in the household sector, the considerable monetary policy stimulus currently in place will likely remain appropriate for a period of time, after which some modest withdrawal will likely be required, consistent with achieving the 2% inflation target".
Bottom Line
The BoC may have maintained a tightening bias but the latter was significantly watered down with the central bank now seeing the stimulus currently in place as "appropriate for a period of time". Moreover, the overall statement was more dovish than preceding ones with the BoC stating for the first time "material" excess capacity and hence more subdued inflation than projected in January's Monetary Policy Report.
The outlook is certainly less favourable than say last January when the BoC released its MPR. Note that the Q4 GDP report not only showed lower growth than anticipated by the BoC for the final quarter of last year, but also downward revisions to first half of the year which more than offset the one-tick Q3 upgrade. Overall, assuming potential GDP was unchanged as per January's MPR, the output gap at the end of 2012 was 1.1% (versus the BoC's 1% estimate in January MPR). That doesn't look like much of a difference, but it's enough to delay the closure of the output gap to 2015 unless of course the BoC raises its growth forecasts for some of the quarters this year or next. For now, the BoC can't quite do that given the major downside risks to its forecasts, e.g. government and investment spending both of which showed healthy 2013 contributions to growth in January's MPR. It's clear that fiscal drag in coming, particularly at the provincial level, while investment intentions for this year, as per Statistics Canada's report last week, are modest at best. So rate hikes are off the table this year. What about rate cuts? Barring an unlikely recession, we don't see that happening either this year given the still-pressing problem of household debt. True, consumer credit growth has moderated but that's unlikely to entirely satisfy a BoC still concerned about overall debt level. We continue to expect the next move to be a hike, starting in Q3 of 2014. The C$ could find some support later on given that markets are currently pricing-in some probability of rate cuts which, in our view, are unlikely to materialize.
Here is the press release (sections highlighted by us).
The Bank of Canada today announced that it is maintaining its target for the overnight rate at 1%. The Bank Rate is correspondingly 1 1/4% and the deposit rate is 3/4%.
The global economic outlook is broadly consistent with the Bank’s projection in its January Monetary Policy Report (MPR). Global financial conditions remain stimulative, despite recent volatility. In the United States, the economic expansion is continuing at a gradual pace and private sector demand is gaining momentum. Fiscal drag in the United States over the next two years remains consistent with the Bank’s January projection, although it is likely to be more front-loaded as a result of sequestration cuts. The recession in Europe continues. Growth in China has improved, while economic activity in some other major emerging economies is expected to benefit from policy stimulus. Commodity prices have remained at historically elevated levels, although persistent transportation bottlenecks are leading to continued discounts for Canadian heavy crude oil.
Canada’s economy grew by 0.6% at annual rates in the fourth quarter of 2012, with solid growth across most domestic components of GDP offset by a sharp reduction in the pace of inventory investment. The Bank expects growth in Canada to pick up through 2013, supported by modest growth in household spending combined with a recovery in exports and solid business investment. With a more constructive evolution of imbalances in the household sector, residential investment is expected to decline further from historically high levels. The Bank expects trend growth in household credit to moderate further, with the debt-to-income ratio stabilizing near current levels. Despite the expected recovery in exports, they are likely to remain below their pre-recession peak until the second half of 2014 owing to restrained foreign demand and ongoing competitiveness challenges, including the persistent strength of the Canadian dollar.
Total CPI inflation has been somewhat more subdued than projected in the January MPR as a result of weaker core inflation and lower mortgage interest costs, which were only partially offset by higher gasoline prices. Low core inflation reflects muted price pressures across a wide range of goods and services, consistent with material excess capacity in the economy. Core and total CPI inflation are expected to remain low in the near term before rising gradually to reach 2% over the projection horizon as the economy returns to full capacity and inflation expectations remain well-anchored.
Reflecting all of these factors, the Bank has decided to maintain the target for the overnight rate at 1%. With continued slack in the Canadian economy, the muted outlook for inflation, and the more constructive evolution of imbalances in the household sector, the considerable monetary policy stimulus currently in place will likely remain appropriate for a period of time, after which some modest withdrawal will likely be required, consistent with achieving the 2% inflation target.
Information note: The next scheduled date for announcing the overnight rate target is 17 April 2013. The next full update of the Bank’s outlook for the economy and inflation, including risks to the projection, will be published in the MPR at the same time.
Bottom Line
The BoC may have maintained a tightening bias but the latter was significantly watered down with the central bank now seeing the stimulus currently in place as "appropriate for a period of time". Moreover, the overall statement was more dovish than preceding ones with the BoC stating for the first time "material" excess capacity and hence more subdued inflation than projected in January's Monetary Policy Report.
The outlook is certainly less favourable than say last January when the BoC released its MPR. Note that the Q4 GDP report not only showed lower growth than anticipated by the BoC for the final quarter of last year, but also downward revisions to first half of the year which more than offset the one-tick Q3 upgrade. Overall, assuming potential GDP was unchanged as per January's MPR, the output gap at the end of 2012 was 1.1% (versus the BoC's 1% estimate in January MPR). That doesn't look like much of a difference, but it's enough to delay the closure of the output gap to 2015 unless of course the BoC raises its growth forecasts for some of the quarters this year or next. For now, the BoC can't quite do that given the major downside risks to its forecasts, e.g. government and investment spending both of which showed healthy 2013 contributions to growth in January's MPR. It's clear that fiscal drag in coming, particularly at the provincial level, while investment intentions for this year, as per Statistics Canada's report last week, are modest at best. So rate hikes are off the table this year. What about rate cuts? Barring an unlikely recession, we don't see that happening either this year given the still-pressing problem of household debt. True, consumer credit growth has moderated but that's unlikely to entirely satisfy a BoC still concerned about overall debt level. We continue to expect the next move to be a hike, starting in Q3 of 2014. The C$ could find some support later on given that markets are currently pricing-in some probability of rate cuts which, in our view, are unlikely to materialize.
Here is the press release (sections highlighted by us).
The Bank of Canada today announced that it is maintaining its target for the overnight rate at 1%. The Bank Rate is correspondingly 1 1/4% and the deposit rate is 3/4%.
The global economic outlook is broadly consistent with the Bank’s projection in its January Monetary Policy Report (MPR). Global financial conditions remain stimulative, despite recent volatility. In the United States, the economic expansion is continuing at a gradual pace and private sector demand is gaining momentum. Fiscal drag in the United States over the next two years remains consistent with the Bank’s January projection, although it is likely to be more front-loaded as a result of sequestration cuts. The recession in Europe continues. Growth in China has improved, while economic activity in some other major emerging economies is expected to benefit from policy stimulus. Commodity prices have remained at historically elevated levels, although persistent transportation bottlenecks are leading to continued discounts for Canadian heavy crude oil.
Canada’s economy grew by 0.6% at annual rates in the fourth quarter of 2012, with solid growth across most domestic components of GDP offset by a sharp reduction in the pace of inventory investment. The Bank expects growth in Canada to pick up through 2013, supported by modest growth in household spending combined with a recovery in exports and solid business investment. With a more constructive evolution of imbalances in the household sector, residential investment is expected to decline further from historically high levels. The Bank expects trend growth in household credit to moderate further, with the debt-to-income ratio stabilizing near current levels. Despite the expected recovery in exports, they are likely to remain below their pre-recession peak until the second half of 2014 owing to restrained foreign demand and ongoing competitiveness challenges, including the persistent strength of the Canadian dollar.
Total CPI inflation has been somewhat more subdued than projected in the January MPR as a result of weaker core inflation and lower mortgage interest costs, which were only partially offset by higher gasoline prices. Low core inflation reflects muted price pressures across a wide range of goods and services, consistent with material excess capacity in the economy. Core and total CPI inflation are expected to remain low in the near term before rising gradually to reach 2% over the projection horizon as the economy returns to full capacity and inflation expectations remain well-anchored.
Reflecting all of these factors, the Bank has decided to maintain the target for the overnight rate at 1%. With continued slack in the Canadian economy, the muted outlook for inflation, and the more constructive evolution of imbalances in the household sector, the considerable monetary policy stimulus currently in place will likely remain appropriate for a period of time, after which some modest withdrawal will likely be required, consistent with achieving the 2% inflation target.
Information note: The next scheduled date for announcing the overnight rate target is 17 April 2013. The next full update of the Bank’s outlook for the economy and inflation, including risks to the projection, will be published in the MPR at the same time.