Bank of Canada holds the line - for now
SLGI Portfolio Management team
Opinions as of September 4, 2019
Central banks around the world, fearing the U.S./China trade war is pushing the global economy into a deepening slowdown, have been cutting interest rates. But with the domestic economy showing a resilient labour market, firming housing sector and 3.7% annualized increase in GDP in the second quarter, the Bank of Canada left its key interest rate unchanged at 1.75%. However, the positive news on Canada’s trade-dependent economy may be behind us, and the bank appeared to lay the groundwork for a possible rate cut at its October meeting. “As the U.S.-China conflict has escalated, world trade has contracted and business investment has weakened,” the bank stated. “This is weighing more heavily on global economic momentum than projected.”
The bank noted that Canada’s strong second-quarter growth, supported by a jump in net exports, exceeded its most recent forecast. Inflation also remained within the BoC’s target level. That said, the bank had already cut its growth forecast for 2020 from 2.1% to 1.9% in its July Monetary Policy Report. And if it continues, the bank believes the trade dispute could shave as much as 2% off the country’s GDP by 2021.
The BoC’s lower-growth projections appear to becoming a reality, with net trade and manufacturing sentiment pulling back over recent weeks. That leaves the door open for the BoC to cut interest rates in the coming months, subject to incoming data, with the bank saying it “will pay particular attention to global developments and their impact on the outlook for Canadian growth and inflation.”
While its starting point on rates is more accommodative, the BoC’s decision not to cut interest rates put it at odds with other central banks. Among those, the U.S. Federal Reserve, blaming sluggish business investment and stubbornly low inflation, lowered its key lending rate by 25 bps on July 31 – its first rate cut in eight years. And citing the threat of a global recession, central banks in New Zealand, Thailand and India also cut interest rates.
Major central banks and their key interest rates
Source : Bloomberg
Given Canada’s trade reliance on the U.S. market, the BoC also has to consider keeping its key lending rate relatively in sync with the Fed. If not, the bank risks propping up a higher Canadian dollar, which hinders Canadian exports. While we see the Fed possibly cutting at least one more time this year, at one point the market had priced in as many as three reductions. If that were to happen, the BoC could have one of the highest overnight rates among major central banks, potentially making it difficult for the bank not to follow the Fed lower.
The future direction of interest rates has also been clouded by politics. Speaking at a gathering of central bankers at Jackson Hole on August 23, Fed Chair Jerome Powell said the U.S. economy was performing well. However, he also said the tariff battle had steered the world economy into uncharted waters, and that monetary policy could not “provide a settled rulebook for international trade."
Powell’s statement seemed to suggest that at this point, while the Fed is closely monitoring the fallout from the trade dispute, he is not linking interest rate policy directly to it. Indeed, U.S. President Donald Trump immediately rebuked Powell’s comments, even labelling him an “enemy” of the U.S. And he again demanded that the Fed cut rates at a faster and deeper pace.
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