The Bank of Canada reassessed the outlook for the Canadian economy however, it continued to hold the key interest rate.

Just as the global outlook brightens, Canadian households have gone wobbly, forcing the Bank of Canada to reassess its outlook, though not enough to change its benchmark interest rate.

Consumer spending slowed during the second half of 2019 and the trade wars haven’t calmed enough to offset the loss of Canada’s primary economic engine. The result is a significantly weaker short-term forecast that could prompt the central bank to cut interest rates if current conditions persist.

“There is some downside risk to the outlook for inflation,” Stephen Poloz, the bank’s governor, said at a press conference in Ottawa on Jan. 22. “I’m not saying the door is not open to an interest-rate cut. Obviously, it is. It is open. But it hinges on how the data evolve from here.”

Traders weren’t ready for a pivot from the Bank of Canada. Ahead of the announcement, prices on securities linked to short-term interest rates put the odds of an interest-rate cut in 2020 at essentially nil. That remains the most likely scenario. The jobless rate is about as low as it’s ever been, wages are rising and the housing market in most places is strong. No one is talking about a recession.

But the Bank of Canada could no longer ignore persistent signs of trouble. Business investment “appears to have weakened after a strong third quarter,” hiring “has slowed,” and consumer confidence and spending indicators “have been unexpectedly soft,” policy-makers said in their new policy statement.

In its latest quarterly forecast, the central bank predicted the Canadian economy will grow by 1.6% this year, down 0.1 of a percentage point from its projection in October. Some of that change was the result of a strike at CN Rail and an outage at the Keystone pipeline, and global uncertainty around trade and geopolitical tensions affecting Canada more than previously predicted.

They slashed their forecast for fourth-quarter growth to an annual rate of 0.3% — stall speed. They foresee a recovery, predicting an expansion of 1.6% in 2020 as business investment and exports gradually improve. The Bank of Canada also revised its estimate of the economy’s non-inflationary speed limit to 2%.

The new outlook is one of underperformance, with room for stimulus. Traders now put the odds of an interest-rate increase this year at 50%, according to RBC Capital Markets. The dollar dropped a cent against its U.S. counterpart, settling at around 76 cents U.S.

“Today’s dovish statement could turn out to be a game changer at some point,” said Sébastien Lavoie, chief economist at Laurentian Bank Securities.

Household spending on goods and services increased 0.4% in the third quarter, an improvement from very little growth in the spring, but a poor result by historical standards, according to Statistics Canada’s most recent report on quarterly gross domestic product. (The average quarterly change dating back to 1961 is a 0.8% increase.)

“Data for Canada indicate that growth in the near term will be weaker,” officials said in their policy statement. The slump could “signal that global economic conditions have been affecting Canada’s economy to a greater extent than was predicted,” they added. “Moreover, during the past year Canadians have been saving a larger share of their incomes, which could signal increased consumer caution.”

Nothing in the Bank of Canada’s latest round of communications suggests the economy is in serious trouble.The message is simply that there isn’t as much momentum as previously thought. Policy-makers last year said they would be watching for evidence that the trade wars were spreading beyond corporate decision making. Now, they said, they could be seeing some. Poloz told reporters that the analysis that led to the revised outlook brought a “crystallization of some of the domestic downside risks.”

If the headlines around trade continue to improve, consumer confidence could get better and spending along with it. Exports and business investment should slowly strengthen, which could forestall the need for stimulus. The Bank of Canada emphasized that it remains concerned about re-igniting a borrowing binge, while acknowledging that a higher savings rate would offset some of those concerns.

Ultimately, the central bank cares most about inflation, and weaker growth could bring deflationary pressure. “In determining the future path of the bank’s policy interest rate, Governing Council will be watching closely to see if the recent slowdown in growth is more persistent that forecast,” the statement said.

Sources:
The Toronto Star
Financial Post
The Globe and Mail