The Bank of Canada (BoC) announced last week that it will maintain its target for the overnight interest rate at 1.75%.
At a CFA Society Toronto breakfast, Bank Governor, Stephen Poloz elaborated on the announcement in his final speech of 2018. He told those of us in attendance that the current rate is appropriate for the time being, but that higher rates continue to be warranted going forward.
Future decisions will be driven by economic conditions
His speech struck a more dovish, less aggressive tone compared to October's announcement when the BoC brought rates up to 1.75%. Still, he says rates are eventually expected to migrate to the BoC's neutral range of 2.5% to 3.5%. The Canadian consumer's ability to absorb the increases, business investment and exports are three key areas the BoC will observe to determine the pace of future hikes.
Modest inflationary pressure and a slowdown in business investment growth are two risks which may cause rates to remain at current levels for a longer period than previously expected.
Mr. Poloz did say inflation is on target and economic growth is at capacity. Consumer Price Index (CPI) inflation came in higher, at 2.4% in October, but is expected to ease in coming months, thanks to lower gasoline prices. The BoC says core measures of inflation are all tracking 2.0%, consistent with an economy that is operating close to capacity.
Although this is a natural time to raise rates, he says household debt and housing prices are ongoing considerations for how financial conditions are being absorbed in the real economy. Given that rates have been low for a very long time, this build up of debt is normal.
Canadian economy grows
In its announcement on Wednesday last week, the BoC says the Canadian economy, as a whole, grew in line with projected expectations. Household credit and regional housing markets also appear to be stabilizing but continuing trade conflicts are beginning to weigh more heavily on global demand.
Although business investment fell in the third quarter of 2018, due in large part to heightened trade uncertainty in the summer, business investment outside of the energy sector is expected to strengthen going forward with the signing of the United States Mexico Canada Agreement (USMCA). New federal tax measures, productive capacity increases and strong foreign demand should also continue to support both business investment and export growth.
Oil prices continue to weigh
In releasing its announcement, the BoC also noted that oil prices have fallen sharply since October, reflecting a combination of geopolitical developments, uncertainty about global growth prospects and expansion of U.S. shale oil production. Transportation constraints and a buildup of inventories have also pulled oil prices lower in recent months. In light of these developments and the associated cutbacks in production, it says activity in Canada's energy sector will likely be materially weaker than expected going forward.
It is worth noting that the BoC does not speculate on oil prices, however a prospective recovery would provide confidence for more aggressive rate increases in the future. The BoC expects the recent decline in oil prices to have less of an impact to the Canadian economy than what was experienced in 2015. It's important to recall that the 2015 oil price decline was the rationale for two rate cuts during that year.
As the BoC's decision was widely expected, bond yields and equity markets were little changed. The Canadian dollar did decline relative to the U.S. dollar.
For more information about the BoC announcement and what it can mean for you and your portfolio, please contact your MD Advisor.
About the AuthorMore Content by Wesley Blight