The Bank of Canada is continuing to build a case for higher interest rates – just not right now.
Bucking trends the central bank kept its key rate unchanged at 1.25 per cent on Wednesday, citing weakness in housing, trade and investment in export-oriented sectors.
Even though many of the key ingredients for higher rates are falling into place, the bank said it remains “cautious with respect to future policy adjustments.”
Canada’s economy is operating with “little slack,” while inflation is edging higher and is now roughly in line with the central bank’s critical 2-per-cent target, according to a statement accompanying its rate decision. Consumption growth also remains “robust,” helped by rising wages.
The bank has raised its key rate three times since last June, and investors and economists still expect at least one more hike this year.
Canadian Imperial Bank of Commerce economist Andrew Grantham says the statement suggests the Bank of Canada will make another rate hike, likely in July. But it’s “in no rush” to move again after that.
The Canadian dollar fell about half a cent after the announcement, to 79.12 US cents by midday.
Part of the bank’s go-slow stance on rate hikes is because the economy’s capacity to grow is also expanding. The bank boosted its estimate of potential output growth by two to four percentage-points in each of 2018, 2019 and 2020, according to its latest Monetary Policy Report, released Wednesday. The median is now expected to be 1.8 per cent in all three years.
If the bank is right, more capacity will allow the economy to grow at a faster clip without sparking inflation.
The economy is now expected to grow at an annual rate of 1.3 per cent in the first three months of this year, down from the 2.5 per cent it forecast in January, the central bank said.
For the whole of 2018, the bank is calling for the economy to grow 2 per cent, down from a previous estimate of 2.2 per cent. But growth will be a bit stronger than expected in 2019 and 2020, at 2.1 per cent 1.8 per cent respectively, reflecting the impact of recent federal and provincial fiscal measures, according to the bank.
For now, at least, Bank of Canada Governor Stephen Poloz and his top officials seem more preoccupied with factors holding back the economy than all the things going right.
“Both exports and investment are being held back by ongoing competitiveness challenges and uncertainty about trade policies,” the bank said.
Meanwhile, tighter federal mortgage rules, introduced in January, are weighing on housing activity, particularly in the once-booming Toronto market.
It added that “some of that weakness” in housing and exports will be unwound later in the year.
The bank also warned that “escalating geopolitical and trade conflicts risk undermining the global expansion.”
In recent months, the United States and China have squared off with threats of steep tariffs on thousands of each others’ main exports. The tit-for-tat moves have sparked fears of a damaging global trade war between the world’s two largest economies.
The future of the North American free-trade agreement also remains unclear. U.S. officials have suggested in recent weeks that a tentative agreement may be near on key details, including auto-sector rules, but many other contentious issues remain unresolved.
The bank also highlighted “transportation bottlenecks” – an apparent reference to ongoing struggles by Canada’s two major railroads to keep up with shipments of grain, lumber, crude oil and other commodities in recent months.
Particularly worrying is the fact that Canada is still losing its share of non-energy imports in the vital U.S. market, even as the Canadian dollar has depreciated in recent years, the bank pointed out in the Monetary Policy Report. The bank blamed the problem on competition from China, protectionism as well as a contraction of the auto sector, triggered by the failure of car plants in Canada to get work on new lines of vehicles.
And inflation is perking up. The bank said it now expects the consumer price index to rise 2.3 per cent this year, versus a previous estimate of 2 per cent. The bank says inflation will be 2.1 per cent in both 2019 and 2020.
The single greatest downside risk to that outlook is “a notable shift toward protectionist global trade policies,” according to the forecast.
Among the bank’s other main worries: a hit to heavily indebted borrowers from higher interest rates as well as “a sizable decline in house prices” in some markets. On the upside, the U.S. economy could grow faster than expected, boosting demand for Canadian exports.
Get your FREE home evaluation here.