Temporary nature of slowdown to keep Bank on hold - Capital Economics
Canada Economics

Temporary nature of slowdown to keep Bank on hold

Bank of Canada Watch
Written by Stephen Brown

Next week the Bank of Canada is likely to once again trim its forecast for GDP growth. But as temporary factors are partly to blame and there have been several positive external developments in recent weeks, the Bank is set to remain firmly on the side lines.

  • Fourth-quarter GDP probably unchanged – vs Bank’s forecast of 1.3% gain
  • But temporary factors largely to blame and business surveys point to rebound
  • Bank to remain on hold throughout 2020

Next week the Bank of Canada is likely to once again trim its forecast for GDP growth. But as temporary factors are partly to blame and there have been several positive external developments in recent weeks, the Bank is set to remain firmly on the side lines.

Some reasons to be gloomy

The slump in the economic surprise index, which compares the results of a broad selection of data releases with expectations, perhaps best sums up domestic developments since the Bank’s last meeting in early December. (See Chart 1.)

Chart 1: Economic Surprise Index

Sources: Citi, Refinitiv, Capital Economics

The poor data releases culminated in a 0.1% m/m fall in GDP in October and lead us to think that GDP fell by 0.2% in November. This in turn suggests that GDP stagnated, at best, in the fourth quarter, which would be far weaker than the Bank’s most recent forecast for a 1.3% annualised gain.

More reasons to be positive

Despite the gloomy data, there are several reasons why an interest rate cut still looks unlikely. For a start, most of the further slowdown in the fourth quarter reflects temporary factors. The GM strike in the US weighed on the auto sector in September and October, the rupture of the Keystone pipeline sharply curtailed energy exports in November, and the CN Rail strike weighed on trade in both directions. As those factors unwind, GDP should rebound strongly in December. That’s certainly what the timely rail freight data suggest, with railcar loadings rising in December to their highest level in four months. If we’re right that GDP rebounded by 0.5% m/m, then growth in the first quarter would most likely surpass 2% annualised – far stronger than the Bank’s forecast for growth of about 1.5%.

Looking through the noise, the surveys point to an improvement in momentum. The Future Sales Indicator of the winter Business Outlook Survey (BOS) was at a six-quarter high of 33%. It points to a rebound in annual GDP growth to over 2%, from our estimate of 1.5% in the fourth quarter. (See Chart 2.)

Chart 2: BOS Future Sales Indicator & GDP

Sources: Refinitiv, Capital Economics

The BOS also painted an encouraging picture of the labour market. Although Governor Stephen Poloz said that the Bank doesn’t place much weight on single data points, the 71,000 slump in the LFS measure of employment in November surely raised a few eyebrows. Employment partially rebounded in December, by 35,000, and the BOS measure of hiring intentions rose to its highest level since the second quarter of 2018. It suggests the economy should add far more private sector jobs in the next six months than the meagre 8,000 added since June last year. (See Chart 3.)

Chart 3: BOS Hiring Intentions & Private Sector Jobs

Sources: Refinitiv, Capital Economics

The BOS results are particularly encouraging since the survey was carried out before the US and China provisionally agreed to their Phase One trade deal and before the US Democrats agreed to support the new NAFTA in the House of Representatives. The Bank believes that trade uncertainty has had large negative effects on the economy, so will be hopeful of a further rise in sentiment in the next BOS.

Downsides of looser policy

Even if it weren’t for these positive developments, Poloz would probably want to see further evidence that stimulus was really needed, given the potential effects that looser policy might have on household debt and the housing market. While home sales have edged down since the Bank’s last meeting, an even larger fall in new listings means that the sales-to-new listing ratio has risen to its highest level in over 15 years. We’re doubtful that house price inflation will rise to 15% as Chart 4 seems to suggest, but it would be a strange decision for a Governor concerned about household debt to cut in this environment.

Chart 4: Sales-to-new Listing Ratio & House Prices

Sources: CREA, Refinitiv, Capital Economics

The results of the Bank’s newly released Survey of Consumer Expectations also highlighted the potential risks to financial stability. Consumers expectations for house price inflation were the highest in five quarters, driven mainly by expectations for stronger gains in British Columbia where prices look most stretched relative to incomes. Consumers also reported that weaker expectations for income growth hadn’t negatively affected their spending plans. The gap between consumers’ spending and income growth expectations is the second widest in the survey’s short history (see Chart 5), implying consumers intend to take on more debt.

Chart 5: HH Income & Spending Growth Expectations (% y/y)

Source: Bank of Canada

A cautious message

Although there are reasons to be positive about the outlook, the further slowdown in GDP growth in the final quarter means that the Bank is likely to trim its estimate of 2019 GDP growth as well as its forecast for 2020. While the Bank might use the signing of the Phase One trade deal between US and China to nudge up its forecasts further ahead, those downward adjustments, combined with the fact that the Bank’s forecasts for the next two years already looked pretty weak, mean that the Bank is likely to sound a cautious note in its policy statement.

There has been some speculation that the Bank might even try to talk the loonie down, given its strong rise in December and the first week of January seemed at odds with the weakness of the activity data. That appears to be only a minor risk, however. While the loonie appreciated by 2.5% against the greenback from its November low to its early January high, it has since weakened again and is now only 1.2% higher against the greenback compared its average over the second half of the year and only 0.6% higher on a trade-weighted basis.

Table 1: Bank of Canada Background Information

Policy Interest Rate Announcements

The Bank of Canada has a system of eight pre-set dates per year on which it announces its target for the overnight interest rate (10.00am EST).

Release of Minutes

No. However, the Bank’s Monetary Policy Report (MPR), published four times a year, provides considerable detail on the Governing Council’s outlook for economic activity and inflation, the key risks around this outlook, and the reasons for the recent interest rate decision.

Disclosure of Voting

No.

Inflation Target

Yes. The Bank aims to keep inflation at 2%, the midpoint of a 1% to 3% range.

Policy Framework

Canada’s monetary policy is built on a framework consisting of two key components. The first component is a flexible exchange rate, which permits independent monetary policy. The second component is the inflation target of 2%, which provides a precise goal to measure the conduct of monetary policy.

Membership of the Governing Council

The Governing Council is the policy-making body of the Bank. It consists of the Governor, Senior Deputy Governor, and four Deputy Governors.

Governor

Stephen Poloz

Senior Deputy Governor

Carolyn Wilkins

Deputy Governors

Timothy Lane

Lawrence Schembri

Paul Beaudry
Toni Gravelle

Fixed Announcement Dates

Date

Outcome / Our Forecast

July 10th

No Change (Rate to stay at 1.75%)

September 4th

No Change (Rate to stay at 1.75%)

October 30th

No Change (Rate to stay at 1.75%)

December 4th

No Change (Rate to stay at 1.75%)

January 22nd 2020

No Change (Rate to stay at 1.75%)

March 4th

No Change (Rate to stay at 1.75%)

April 15th

No Change (Rate to stay at 1.75%)

June 3rd

No Change (Rate to stay at 1.75%)

Sources: Bank of Canada, CE


Stephen Brown, Senior Canada Economist, +1 416 874 0514, stephen.brown@capitaleconomics.com