Since the end of December, overnight index swaps have moved from pricing in no change in monetary policy over the next two years to implying 40 bp of loosening. We had expected some move in that direction, as we thought that a further deterioration in the data would force the Bank of Canada to cut its growth forecasts, which it did at its meeting last week. While the Bank’s dovish policy statement pushed down the implied policy rate for the end of 2021 by 25 bp, the further 15 bp move has occurred in the past two trading days amid increased fears about the spread of the Wuhan virus. Given that monetary policy works with a long lag and the experience of previous outbreaks suggests that any negative effects on the economy are likely to be short-lived, at this stage we are not convinced that the virus will have much sway on the Bank’s policy setting. We continue to think that the most likely outcome is that the Bank will remain on hold this year, particularly as there are signs that, after two months of negative growth, GDP rebounded strongly in December.
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