BOC To Leave Policy Rate At 1%

The BOC is expected to keep the overnight rate unchanged at 1% in January. While both external economic headwinds and domestic problems are posing threats to Canada's economic outlook, recent encouraging macroeconomic data from the US should help the BOC buy time in assessing the big picture before making a decision. It's likely that the central will leave the monetary policy as it is for the rest of the year. Should the Fed announce in coming meetings that interest rates will stay unchanged at exceptionally low levels longer than mid-2013, the BOC would even be harder to alter its policy.

Domestically, data released recently have been worrisome. A BOC business survey released last week showed an increasing number of firms feeling pessimistic about the rate of sales growth. Among those surveyed, 41% said they expected their sales pace to slow, as opposed to 37% that expect an increase. The rest were neutral. According to the report, 'the weak U.S. economic outlook, concerns about adverse effects from the situation in Europe and an expected slowing in household spending were among the factors dampening sales prospects'. The recent employment report was also disappointing. The number of payrolls increased +17.5K in December, following a -18.6K decline in the prior month. However, the number of positions added was not enough to offset growth in the labor force, resulting in the rise in the jobless rate to 7.5% from 7.4% in November.

Externally, Canada's economic outlook has been affected by persistence of the sovereign debt crisis in the Eurozone, the US economy and the US fiscal consolidation, as well as whether China would land softly. While debt problems in the Eurozone continue to deteriorate, recent data released in the US have shown improvements that would benefit Canadian exports. The US market represents 72% of Canada's total foreign sales, an improved outlook in the US market should contribute to Canada's wellbeing. ISM manufacturing index managed to stay above 50, signaling expansion, while many other countries fell to the contractionary territory. In December, the reading rose to 53.9, up from 52.7 and 50.8 in November and October respectively. Other forward-looking indicators also showed good signs. The Conference Board's Index of Leading Indicators has been staying positive since mid-2011 while the University of Michigan's Index of Consumer Confidence has been climbing higher over the past 5 months. More importantly, the US job market has improved ahead of the expectations at the end of 2011. In December, The number of payrolls increased 200K and the unemployment rate fell to 8.5%, the lowest level since February 2009. If the trend of the US recovery continues, it should help boosting Canada's economy through trades.

The lingering crisis in the Eurozone and the improving US are offsetting each other, resulting in a pause in BOC's monetary policy. The status quo is reinforced by the country's inflation which has been staying within the central bank's target range of 1-3%, and the high ratio of household debt to incomes (lower interest rates would encourage even more borrowing).