Canada: BoC maintains policy rate at 0.50%, strikes more hawkish tone in May
May 24, 2017
On 24 May, the Bank of Canada (BoC) left its target for the overnight rate unchanged at 0.50%—the fifteenth consecutive time it has done so since July 2015. The decision to hold off on any rate changes for another month was widely expected by market analysts.
The BoC struck an optimistic tone as it acknowledged the economy’s growth prospects this year. Ahead of Statistics Canada’s Q1 GDP announcement on 31 May, growth in the first quarter is expected to have been strong. Resiliency in the economy was likely due to a broad-based improvement in the labor market which has benefited consumer spending coast-to-coast, and a recent uptick in the stubbornly-low business investment. The economy—and, in particular, the energy sector—has also largely completed its medium term adjustment to lower oil prices. Although these factors favor the Bank raising rates in the short term, they were ultimately outweighed by a clouded global and Canadian outlook. In particular, weak Q1 growth in the United States—although largely due to temporary factors—fits with the Bank’s view that growth will be slow to pick up.
Moreover, additional pressure to raise rates has increased in recent months as worsening housing market dynamics have overheated the property markets in Toronto and Vancouver, risking an outsized correction. Although recent policy measures to rein in mortgage lending have kept debt profiles broadly sustainable, sky-high consumer debt levels have continued inching up and, at 167% of disposable income, they remain the highest among the G7 economies. While market analysts have suggested that sooner or later the Bank will need to hit the brakes on cheap borrowing as asset prices soar skyward, BoC Governor Stephen Poloz has made it clear that raising rates is not seen by the Bank as an effective mechanism to curb the overheated housing market.
While the Bank expects significantly stronger growth this year, below-midpoint inflation points to persistent excess capacity in the economy. In leaving rates unchanged, it made clear that the economy still faces other considerable challenges going forward including global competitiveness, labor productivity, and ongoing trade disputes with the United States. All things considered, however, the Bank struck its most hawkish tone in years in its 24 May report, likely leaving the door open for a rate hike as early as H1 2018—when the economy is expected to reach potential output and close the output gap. In fact, while only 10.5% of panelists expect the first rate hike by end-Q4, 87.5% of our panelists forecast at least one rate hike by end-H1 2018. In the short term, the Bank’s noted caution puts it at odds with the ongoing tightening cycle of the U.S. Federal Reserve.
The next monetary policy announcement is scheduled for 12 July.
Author: Christopher Thomas, Economist