Bank of Canada: Same Message, More Clarity

• Plus ça change, plus c’est la même chose. A change at the top didn’t really bring substantive change to the Bank of Canada’s view on the economy, or its expectations for when it will move on interest rates. But if Governor Carney was judged to be a good communicator, Stephen Poloz is trying to go one better, as he left his mark largely in adding some greater clarity about the conditions that will determine when the central bank begins to lift interest rates.

• To us, it’s always been clear that, barring an overheating in household debt that other policy measures couldn’t tame, the timing of interest rate hikes will largely be guided by the economy’s progress towards a zero output gap, and the related signals of inflation pressures. But recent statements by the Bank have only referred to keeping rates on hold for a “period” and then raising them. The market had begun to price-in some risks of rate hikes a bit earlier than might be justified by readings on inflation and economic slack. So Governor Poloz’s team now spelled out what would
define that “period”, if not with anywhere near the precision that we have seen from the US Fed. It still implicitly warns that it wants to see a “constructive evolution” in the household debt picture in order to be comfortable keeping rates this low, but our forecast and the Bank’s would be consistent with a leveling out in debt-to-income benchmarks.

• If rate hikes will be tied to slack and inflation, ultimately, the Bank’s internal forecast for its own rate decisions hasn’t budged. The “new” forecast still sees the output gap at 1¼% and closed in mid-2015, and inflation getting to the 2% target in that timeframe, all in line with the “old” forecast. The near term path of inflation was marked down a bit, and growth was rebalanced
to have three ticks more in 2013 (at 1.8%) and nudged down only one tick to 2.7% in 2014. Our view is that its 2013-14 growth forecast is on the high side of what’s likely, enough to delay the first rate hike until early 2015. As they say, we’ll see, but even in the Bank’s forecast there’s nothing that would compel a rate change in the next four quarters.

• While it’s on the optimistic side quantitatively, the Bank of Canada’s story for growth isn’t markedly different from CIBC’s view. Exports and related capital spending will have to take the lead in any Canadian acceleration next year, although we see the competitiveness challenges in Canada as requiring global growth to significantly top the Bank of Canada’s projection to spark that turn. In its statement, the Bank dropped its earlier reference to the “persistent strength” of the Canadian dollar as a factor impeding exports, in line with Poloz’s reluctance to be cast as one seeking a weaker
loonie in his first press appearances. But the MPR still notes that in sectors like lumber and autos, Canada’s response to better US demand has been muted by location decisions made in recent years that reflect “relative cost structures”, without citing the C$ as behind them.

• It’s often instructive to look at the special topic boxes as a guide to what’s puzzled the Bank of late. The expected drop in core inflation gets a special look, with its researchers pointing to weakness in core food inflation from global and Canadian retail competition factors, as well as some one-off hits to regulated prices. It judges these as “special factors” rather than evidence of greater domestic
slack, which explains why they have not chosen to widen the estimate of the output gap.

• Add it all up, and we have a central bank that’s appropriately in no hurry to move off a very stimulative 1% interest rate target, and will only do so when there’s better growth, less slack, and at least some risks that inflation pressures will build. In CIBC’s view, that could leave the overnight rate on hold for another year and half; the Bank’s forecast would likely imply a rate hike a couple of
quarters earlier. Either way, it’s going to be some time before there’s any real fireworks at the short end of the Canadian yield curve, and longer term bond yields will be listening more to Ben Bernanke or his successor than anything that Governor Poloz says.



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