Bank to wait and see amid virus fears - Capital Economics
Canada Economics

Bank to wait and see amid virus fears

Canada Economics Weekly
Written by Stephen Brown

Overnight index swaps now imply a 65% chance that the Bank of Canada will respond to fears about the spread of the coronavirus by cutting interest rates next week. But cases of the virus in Canada are still limited to just 14, and the Bank is concerned about the consequences of looser policy for the housing market. While the virus may eventually force the Bank’s hand, for now we expect it to remain on the side lines.

Overnight index swaps now imply a 65% chance that the Bank of Canada will respond to fears about the spread of the coronavirus by cutting interest rates next week. But cases of the virus in Canada are still limited to just 14, and the Bank is concerned about the consequences of looser policy for the housing market. We think the Bank would only cut if it were convinced that the disruption caused by the virus elsewhere in the world has already been enough to seriously jeopardise domestic growth.

Absent a domestic outbreak, the three main channels through which the virus might dent growth are weaker exports, disruption to supply chains or lower commodity prices. As we explained in our Bank of Canada Watch, Canada is less exposed than many advanced economies to export demand from four of the most severely affected countries of China, Japan, South Korea and Italy.

In terms of the potential hit to supply chains, 18% of goods imports come from those four countries, but Canada is more reliant on them for final consumption and investment goods rather than goods that are used as inputs in the production process. (See Chart 1.) This suggests there is a smaller imminent risk to production in Canada than in many other places, although the manufacture of products such as autos and planes can be halted by the absence of just one key component.

Chart 1: Canada’s Imports (% of total)

Source: Statistics Canada

The sharp downward moves in commodity prices are a bigger immediate risk, but volatile market moves may not be enough to persuade the Bank to cut either. At $45, WTI is now 25% below the $60 that the Bank assumed when it produced the forecasts in its January Monetary Policy Report. But last year, the Bank changed the way it forecasts activity in the oil sector so that it is now based on Alberta’s production ceiling and pipeline and rail capacity rather than relying mainly on oil prices. So the potential hit to its growth forecasts from a 25% drop in oil prices will not be as large as in the past.

The Bank should also be encouraged by the data this week. While the 0.3% annualised rise in GDP in the fourth quarter was in line with the Bank’s estimate, the 0.3% m/m jump in December provides a stronger hand-over to the first quarter than the Bank was expecting. The rail data for last week were also better than we expected. Instead of falling further after the shutdown of CN Rail’s eastern network, freight loadings picked up. It now looks like they fell by 6% in February, rather than the 12% drop we previously feared. Given all this, we’re shifting our forecast for first-quarter growth back to 1.8% annualised, which is stronger than the Bank’s forecast of 1.3%.

Ultimately, we think the members of the Governing Council will share the views of their peers elsewhere in the world. With the Bank of Korea itself keeping policy unchanged this week despite the disruption to the Korean economy that they have already seen, the European Central Bank President Christine Lagarde saying that the coronavirus does not yet warrant a policy response, and Federal Reserve officials playing down the likelihood of an immediate cut, the Bank of Canada seems unlikely to cut interest rates yet either.

All that said, it clearly would not take much more to change the Bank’s mind. While it has been worried about the effects of looser policy on house prices, it may become more welcoming of a further boost to housing wealth if equity values continue to plummet.

The week ahead

Aside from the Bank of Canada’s meeting, we expect to learn next week that the trade balance widened in January, while of employment increased in February.


Data Preview – International Trade (Jan.) 08.30 Fri. 6th Mar.

Forecasts

Previous

Median

Capital Economics

Merchandise Trade Balance (C$bn)

-0.4

-0.6

Exports and imports declined

We estimate that exports declined by more than imports in January, which caused the deficit to widen.

Following the 1.9% m/m rise in December, exports seem to have declined in January. December’s increase was partly due to a 15% m/m jump in exports of oil by rail to just shy of 350,000 barrels per day (bpd). But the advance US trade data showed a steep drop in imports of industrial supplies, which implies that Canada’s oil exports dropped back again. Business surveys point to weak exports from other sectors as well, so we are pencilling in a fall of 0.7% m/m. Meanwhile, imports were boosted in December by a couple of one-off effects including a jump in pharmaceutical imports. We’ve pencilled in a 0.3% m/m decline as those one-offs are reversed.

Our forecasts imply that the trade deficit widened to $0.6 bn, from $0.4 bn. In February, the nationwide rail blockades are likely to have weighed more heavily on exports than imports. The data for the first three weeks of February show that rail freight loadings slumped by 8% compared to January. (See Chart 2.) This implies the trade deficit widened further.

Chart 2: Rail Freight Car Loadings (%m/m)

Source: Refinitiv

Data Preview – Labour Force Survey (Feb.) 08.30 Fri. 6th Mar.

Forecasts

Previous

Median

Capital Economics

Change in Employment (000s)

+35,000

+20,000

Unemployment Rate (%)

5.5%

5.5%

Average Hourly Wages (% y/y)

+4.2%

+3.4%

Another healthy rise

We expect a rise in employment of about 20,000 in February despite the rail blockades.

It is too soon for the outbreak of the coronavirus to have had much of an effect on employment, and in theory we should not see much of a negative effect from the rail blockades either. The LFS data were collected in the third week of February, which was the same week that VIA Rail temporarily laid off 1,000 workers and CN Rail furloughed 450 workers, but respondents are asked about their employment situation in the week before. Meanwhile, the end of the extreme weather in British Columbia and Alberta should have lifted employment in those provinces and, as the weather remained unseasonably mild in Ontario and Quebec, it is unlikely that the strong gains seen in January will be completely reversed. Accordingly, we expect to see a rise in overall employment of 20,000.

The labour force probably rose by a similar amount, so that should keep the unemployment rate unchanged at 5.5%. Despite the low rate of unemployment, base effects from strong monthly gains in wages this time last year mean that annual wage growth probably dropped sharply to 3.4%, from 4.2%. We expect it to fall further until it reaches a trough in July. (See Chart 3.)

Chart 3: LFS Hourly Wages (%y/y)

Source: Refinitiv


Economic Diary & Forecasts

Upcoming Events and Data Releases

Date

Release/Indicator/Event

Time EST (GMT-5)

Previous*

Median*

CE Forecasts*

Mon 2nd

Manufacturing PMI (Feb)

09.30

50.6

49.5

Tue 3rd

No Significant Data Released

Wed 4th

Labour Productivity (Q4)

08.30

+0.2%

Bank of Canada Policy Announcement

10.00

+1.75%

+1.75%

1.75%

Thu 5th

No Significant Data Released

Fri 6th

International Merchandise Trade (Jan)

08.30

-C$0.4bn

-C$0.6bn

Unemployment Rate (Feb)

08.30

5.5%

5.5%

Change in Employment (Feb)

08.30

+34,500

+20,000

Hourly Wages (Feb)

08.30

(+4.2%)

+3.4%

Selected future data releases and events

9th March

Housing Starts (Feb)

07.15

Building Permits (Jan)

07.30

11th March

Capacity Utilisation (Q4)

07.30

Existing Home Sales (Feb)

08.30

*m/m(y/y) unless otherwise stated

Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts

%q/q ann. (%y/y) unless stated

Q4 2019

Q1 2020

Q2 2020

Q3 2020

Q4 2020

Q1 2021

2019

2020

2021

GDP

0.3

1.8

2.0

1.8

2.0

2.1

1.6

1.6

2.3

CPI Inflation

2.1

1.9

1.6

1.5

1.5

1.8

1.9

1.7

1.8

Unemployment Rate (%)

5.8

5.6

5.8

6.0

5.8

5.6

5.7

5.8

5.6

Overnight Rate, End Peri’d (%)

1.75

1.75

1.75

1.75

1.75

1.75

1.75

1.75

2.00

10 Yr GoC., End Period (%)

1.59

1.35

1.55

1.70

1.75

1.80

1.59

1.75

2.00

USD/CAD, End Period

0.77

0.75

0.77

0.78

0.79

0.80

0.77

0.79

0.82

Sources: Refinitiv, Capital Economics


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