The Bank of Canada kept its overnight rate unchanged at 1.75% this morning, as was widely expected. The short statement accompanying the decision took a dovish bent.

The Canadian economy lost significant momentum in the latter half of 2018, in part due to oil sector curtailments, but the weakness made itself evident in nearly all components, such that final domestic demand contracted for a second quarter. This was acknowledged in today’s statement, which noted that “the slowdown in the fourth quarter was sharper and more broadly based”. The statement also indicated that the Bank is likely to mark down its 2019 forecast: “it appears that the economy will be weaker in the first half of 2019 than the Bank projected in January”. The Bank had forecast just 0.8% q/q saar growth for 2019Q1 in January.

The Bank also noted that Canada is not alone in seeing a growth moderation, attributing the global growth slowdown to trade tensions and uncertainty that have led other major central banks to acknowledge the headwinds to growth, easing financial conditions.

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On the inflation front, the Bank appears to have slightly downgraded its forecast, now expecting inflation to stay below its 2% target this year reflecting energy price impacts and a softer economic backdrop.

The core message today appears to be that the economy requires more stimulus than previously thought. Gone are references to achieving neutral, instead we are told “the outlook continues to warrant a policy interest rate that is below its neutral range”. At the same time, there remains some bias towards eventual tightening as shown in the statement “increased uncertainty about the timing of future rate increases”.

Key Implications

Borrowing costs are going nowhere fast. The weak end to 2018 and soft momentum heading into 2019 clearly has the Bank of Canada worried about the health of the Canadian economy.

That oil sector developments are holding back near-term growth was a given heading into today’s decision (and last week’s GDP report). What is more concerning is the broad-based economic deceleration, as now acknowledged by Governor Poloz and team. This may be telling the Bank that their past hikes have been more effective than expected, and that they may be closer to a neutral setting than they had thought.

Near-term economic softness, elevated uncertainty, the clear near-term bias to holding rates, and the likelihood that the neutral interest rate is below the Bank of Canada’s estimates all point in the same direction. Unless we see a robust growth recovery mid-year (with that hurdle rising by the day) further rate hikes in 2019 are all but off the table.

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