The big Canadian banks weigh in on today's Bank of Canada decision
CIBC: Today's rate hike was a rear-view mirror move, but the Bank of Canada hints that the view out the front window isn't quite as sunny. Canada did so well in 2017 that it left little slack in labour markets or capacity in its wake, easily justifying a quarter-point hike today. The output gap is now slightly positive, so quarterly growth rates from here have to average below 2% (the Bank has 1.8% for the average of the next four quarters) to avoid an inflationary overheating. We share the Bank of Canada's view that higher rates will be needed over time to stay on that path, but they won’t come quite as fast and furious as the market was starting to think. For one, the Bank's statement put NAFTA uncertainties right up front, and has started to build in a drag on investment and exports into its forecast. While the Bank isn’t ready to assume that NAFTA will be completely cancelled, doubts on that front can impact business sentiment, and they’ve included a 0.5% hit to the level of GDP through the next two years to account for that effect. That creates a little less room for the additional drag of higher interest rates on the domestic economy, and a reason to avoid additional trade woes from having an excessive pace for rate hikes send the loonie still stronger. Interestingly, the Monetary Policy Report highlights a fact that the Bank chose to downplay a bit in the way it worded its Business Outlook Survey. Respondents “are increasingly concerned” about rising protectionism and NAFTA prospects. We can sympathize with those doubts. Our own outlook assumes that, at a minimum, the US puts Canada on notice of its intention to pull out of NAFTA in the months ahead. In a move we believe was aimed at calming market expectations for follow-up hikes a bit, the Bank also left room in its statement to explain that "monetary accommodation" (ie. rates at stimulative levels) will be needed to reach their growth and inflation forecasts, reasserting the need to be cautious in how fast they hike ahead, even to have growth run at roughly potential by 2019. That could be confusing for those who define neutral as the rate needed to grow at potential. But the Bank of Canada is differentiating between some higher long term neutral rate, and the rate that might be neutral in the next year or two given other headwinds, including the extra sensitivity of a household sector carrying a lot of debt. Changes in the forecast were trivial, but that’s to be expected since the Bank of Canada is committed to finding the rate path that steers the economy right to a 2% inflation pace and output running right at potential. It’s not whether growth will slow in the next two years, it’s just how many rate hikes that will take. Overall, this was a dovish statement relative to the minimum degree of optimism needed to justify a rate hike today, and could put some downward pressure on 2-year yields and the value of the C$. We’re looking for one further hike this year, likely early in Q3, and a further 50 bps in 2019. Yes, we’re facing higher rates, but not SO fast given other risks to growth ahead.
RBC: The Bank of Canada ratified market expectations by hiking rates 25bp today, to leave the overnight target rate at 1.25% (OIS markets had priced in the move by ~85%). In its rate statement, the central bank maintained a similar tone seen late last year, reiterating some degree of caution in being “guided by incoming data in assessing the economy’s sensitivity to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation.” However, whereas they stated that higher interest rates “will likely be required over time” in the past, they now suggest “the economic outlook is expected to warrant higher interest rates over time” – perhaps a little clearer indication – even if subtle – that we are now in the process of removing accommodation, though some of that accommodation “will likely be needed to keep the economy operating close to potential and inflation on target”. Other aspects of the rate statement and MPR forecasts/discussions were also about as expected. The Bank’s GDP growth forecasts for 2017 and 2018 were unchanged on balance (revised down 0.1pp in 2017 to 3.0% and up 01pp to 2.2% in 2018, with 2019 growth boosted by 0.1pp to 1.6% to match the Bank’s revised estimate of potential growth – previously 1.5%). Given the blockbuster jobs reports to end 2017, it is also not surprising that “… recent data show that labour market slack is being absorbed more quickly than anticipated”. The mid-point of the Bank’s output gap range was nudged up into an excess demand position in 2017Q4 with a range of- 0.25% to +0.75% of potential GDP and an expectation that inflation – currently close to 2 per cent – is expected to remain there over the projection horizon. Any caution from the central bank remains most closely tied to NAFTA risks, even though Canadian businesses have overcome some of their worries in terms of firm capital spending intentions. Within the MPR, the central bank notes that respondents to the latest Business Outlook Survey expressed trade concerns nevertheless and that “greenfield foreign direct investment into Canada has declined since mid-2016, especially from Europe but also from the United States”. The Bank estimates the net impact of trade policy uncertainty on business investment at 2% by the end of 2019. Overall, the “cautious” catchword from the BoC remains in place even with today’s hike and this may be how additional moves later this year pan out (we expect three more to leave the overnight target at 2.00% by the end of 2018). We concur with the Bank’s assessment that “some accommodation will likely be needed to keep the economy operating close to potential and inflation on target” and we believe that the Bank will need to slow the pace of rate hikes in 2019 (we currently have the overnight rate holding at 2.25%, below the 3.00% mid-point of the Bank’s estimated neutral rate range, largely reflecting the impact of higher rates on high household debt).
Scotiabank: As expected the BoC hiked its policy rate by 25bps to 1.25% and that’s the right thing to have done in my opinion. My read of the overall bias in the full suite of communications including the statement, MPR and press conference is mildly hawkish as the BoC lowered the bar for further rate hikes on balance. OIS markets are pricing most of another hike by April/May which is in keeping with our forecast for timing the next policy move, and two more in total this year which is also in keeping with our forecast. CAD is about a half cent stronger versus the USD than it was earlier this morning after netting out position covering on moves immediately prior to the statement and after digesting all of the information provided by the BoC in its full communciations. A stronger currency in the aftermath makes sense to me. There is nothing in the broad set of communications that stands in the way of further hikes in the relatively near-term. This is a more hawkish statement than markets were anticipating over recent days and it stands to repeat that the overall communications incrementally lowered the bar for further hikes. With the following comment, the door is wide open to further rate hikes: “While the economic outlook is expected to warrant higher interest rates over time, some continued monetary policy accommodation will likely be needed to keep the economy operating close to potential and inflation on target.” That just says they’re open to more hikes but not zipping toward neutral faster than we forecast. This merits elaboration. Do not misinterpret “continued monetary policy accommodation.” Continued monetary accommodation speaks to the spread between the pace of future hikes and a neutral policy rate estimate and should not be interpreted as a dovish signal against the “warrant higher interest rates over time” remark. The BoC can still keep hiking and maintain monetary policy accommodation by remaining below a neutral rate this year and that’s all that this comment implies. The BoC upgraded its assessment of slack to note that the “economy is operating roughly at capacity” whereas in December it was still emphasizing the “continued absorption of economic slack.” This is hawkish. The BoC upgraded its perspective on labour slack and now says “labour slack is being absorbed more quickly than anticipated.” This is hawkish. Global forecasts were revised up and pretty significantly in several cases and this provides an incrementally more hawkish backdrop to then back into implications for the Canadian economy. The US outlook was revised up to 2.6% growth this year (2.2% previously) and by a tick to 2.3% next year. The Eurozone’s growth outlook was revised up four tenths this year to 2.2%. Japan was also revised up and China was kept flat at 6.4% and 6.3% projected growth this year and next. Therefore the global outlook strengthened in this MPR which is a hawkish signal. The BoC upgraded its language on inflation by stating that “looking through these temporary factors, inflation is expected to remain close to 2 percent over the projection horizon.” It did not previously advise it was ‘looking through’ as clearly as it did today and so this is incrementally hawkish. There are nevertheless four ways in which the BoC retained some caution but they are not impediments to the broader messages above that support further tightening and they are not always consistent. They are as follows. 1. On NAFTA, I found the BoC’s communications to be marginally coherent at best. The statement appeared to upgrade NAFTA uncertainties. 2. Potential GDP growth estimates were revised up a tick to 1.6% this year and next but that simply offsets the upward revision to actual GDP growth in each year. The level of potential GDP was revised up by only 0.2% as at 2017Q3 which is fairly trivial and still leaves capacity swinging into net excess demand this year as actual growth outstrips potential growth by about six-tenths in 2018. Further, it’s a bit questionable that the BoC revised up its potential growth estimate by a tick but didn’t change the range accordingly which sits unchanged at 1.1–1.7% this year and 1.1–1.9% next year. The BoC’s discussion on potential growth uncertainties and how improving capital investment and productivity trends might raise the economy’s non-inflationary speed limit is on the minds of many, but a) they may have simply undershot potential growth estimates in the past, and b) at this point they are indicating the bias is toward less slack in terms of how it all nets out. 3. The BoC retained reference to how it will remain ‘cautious’ toward future policy moves as expected and retained data dependent guidance when it said it will be “guided by incoming data in assessing the economy’s sensitivity to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation.” 4. On wages, the BoC issued this paper that indicates an altered preference for the most relevant wage metric. The BoC used to always say wage gains for permanent employees was the preferred measure in the past, but now guides that a common trend measure is preferred. That measure—at 2.2% y/y versus the permanent employees’ measure of 2.9% y/y—is why Poloz now argues that real wage gains are small to absent thus far instead of rising. Regardless, our view is that either measure of wage growth is likely to continue rising this year given reduced labour slack, the further shaking out of the negative drag from the commodity income shock, productivity gains over time and full knock-on effects of minimum wage hikes. The wage cycle in a forward looking sense should reinforce broader inflationary pressures regardless of the measure that is used. The next BoC statement will be on March 7th and we expect no rate move at that meeting. The next BoC communications will include a speech by Senior Deputy Governor Wilkins on February 8th and a speech by Deputy Governor Schembri on February 15th.
17 Jan 2018 - 16:45- Fixed IncomeEconomic Commentary- Source: BMO/CIBC/RBC/Scotiabank
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