Fundamental Analysis

BoC: Poloz Hits Pause and Takes Stock

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As widely expected, the Bank of Canada held its key monetary policy interest rate at 1.00% this morning.  

In the accompanying Monetary Policy Report, the outlook for growth was upgraded somewhat. The Bank now expects growth of 3.1% this year, reflecting the robust growth seen over the first half of the year. Growth of 2.1% is anticipated for 2018 (July: 2.0%), and 1.5% in 2019 (July: 1.6%).

Of note, despite hints at a possible upgrade to estimated economic potential, the Bank left this unchanged overall, bumping up the level by about 0.1 percentage points. As a result, the output gap is seen as being effectively zero, meaning that the economy is running at capacity. 

Despite the closure of the output gap, the Bank sees signs of remaining slack in labour markets, suggesting that there may be "room for more economic growth than the Bank is projecting without inflation rising materially above target"

The Bank views recent inflation numbers as in line with its expectations. A number of factors continue to hold back inflation in the near term, offset somewhat by hurricane impacts on gas prices. With core measures drifting higher, consistent with the absorption of economic slack, the Bank see inflation hitting its target in late 2018, and remaining at that pace thereafter. 

The Monetary Policy Report again provided an assessment of the risks to the outlook. Front and center was the potential for protectionist trade policies, germane in light of recent weak trade numbers and the heating up of the NAFTA renegotiation process. Second on the list was weaker inflation, revised somewhat to focus on the risk of structural factors in holding back price growth. It was not all downside risks however, as stronger U.S. growth remains a potential positive risk for the Canadian economy. 

Key Implications

After the excitement of the summer, Governor Poloz engaged in something of a stock-taking exercise, with today's Monetary Policy Report providing important insight into his thinking in the wake of this summer's back to back rate hikes. As things stand today, it appears that the urgency to increase rates has faded. Indeed, consistent with recent communication, today's statement has a somewhat dovish tilt to it.

A few examples of this tilt are likely worth exploring. High debt levels were again seen as an important factor, implying a higher sensitivity to rates relative to the past. As well, the discussion of the output gap, where closure would normally be taken as an inflationary development, was joined by discussion of perceived labour market softness, suggesting some wiggle room around future price pressures should growth come in stronger than expected. Finally, monetary conditions have become less stimulative as the Canadian dollar has risen, and recent changes to mortgage underwriting guidelines are seen as moderating growth in coming years. 

Indeed, it appears that for the Bank of Canada, the economy is in something of a sweet spot: with the output gap closed and growth expected to remain near its longer-term trend, inflationary pressures are likely to remain modest. As a result, there does not appear to be any immediate urgency to further increase interest rates, although this 'sweet spot' also clearly implies that the current low level of rates will become increasingly unneeded.

Note that the Bank of Canada Governor and Senior Deputy Governor will speak at a press conference at 11:15AM EST.

Author: TD Bank Financial Group Website: http://www.td.com/economics/
TD Bank Financial Group
The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.
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