The hawkish tone in the Bank of Canada’s October statement swung to a much more dovish assessment on Wednesday as the bank held rates at 1.75 per cent, as was widely expected. If there is good news, it is that the BoC retains its prerogative to be flexible. The message is crystal clear: Rate hikes are off the table for now.
The changes to the statement were substantial.
Six weeks ago: “The global outlook remains solid.”
Currently: “The global economic expansion is moderating.”
The fact that the Bank put this in the very first sentence is telling: “…signs are emerging that trade conflicts are weighing more heavily on global demand.”
Energy was absent in the communiqué of six weeks ago, but featured prominently on Wednesday as a pronounced economic headwind. The bank also acknowledged that there “is less momentum going into the fourth quarter.” This certainly is a different shade from the more ebullient macro view espoused in late October.
Six weeks ago, the bank had upwardly revised its projections for business investment and expressed disappointment that “business investment fell in the third quarter,” boiling it down to “heightened trade uncertainty during the summer.” My sense is that the uncertainty has not subsided at all and too much emphasis is being placed on the USMCA, which still may not get through the legislative process south of the border.
The bank still retains a fairly optimistic macro assessment on the housing market, even as it has pared back its bullishness at the margin, saying that “household credit and regional housing markets appear to be stabilizing.”
Try telling that to the Vancouver housing market where sales have collapsed more than 40 per cent over the past year to 10-year lows. And the latest data show that the 12-month trend in household credit has softened to 3.5 per cent, which is the slowest pace seen since the economy was emerging from the deep recession of the early 1980s.
The next two comments are really key.
First, the bank no longer believes the economy is necessarily operating at full capacity.
It says that all of its core inflation measures “are tracking two per cent” and added that this is “consistent with an economy that is operating close to its capacity.” This is a big shift from October, when the BoC came right out and said that the “economy is operating at capacity.” The gap between “close to” and “at” is a mile long.
Second, and this was brand-spanking new: “Downward revisions by Statistics Canada to GDP, together with recent macroeconomic developments, indicate there may be additional room for non-inflationary growth.” The bank didn’t specify what the “recent macroeconomic developments” were, but something tells me it is the notable deceleration across virtually every wage measure.
So the economy is still operating with a gap, it is not at full employment, core inflation is at target, and the economy is set to slow in the fourth quarter with limited visibility thereafter. Not exactly a backdrop favourable for higher interest rates over the near- or intermediate-term.
The bank also carefully chose its words with respect to future tightening. Last time, it said the “policy interest rate will need to rise to a neutral stance” and this time it took a page out of U.S. Federal Reserve Chairman Jerome Powell’s playbook and said that the “policy interest rate will need to rise into a neutral range.”
Most market participants see neutral as the three-per-cent mid-point of the Bank’s own estimated 2.5 to 3.5 per cent range. The new wording sends the message that perhaps neutral is as low as 2.5 per cent.
In October, the bank said that when determining the pace of interest rate hikes, the Governing Council would continue to take into account how the economy is adjusting, given the elevated level of household debt.
In December: “The appropriate pace of rate increases will depend on a number of factors,” and the caveats are numerous. “These include the effect of higher interest rates on consumption and housing, and global trade policy developments. The persistence of the oil price shock, the evolution of business investment, and the bank’s assessment of the economy’s capacity will also factor importantly into our decisions about the future stance of monetary policy.”
The gap between close to capacity and at capacity is a mile long
The reality is that it will take quarters, not just months, to make a full assessment of how this laundry list is going to play out.
One cannot call the December statement a mea culpa or a 180-degree turn, but central bankers tend to move incrementally. But it is an attempt to walk back the rate-hike expectations planted six weeks ago — it is a 90-degree turn, for now.
The tightening bias is still there, but watered down, and it wouldn’t surprise me one iota that by the next meeting, the bank will complete a 180-degree turn and officially switch to neutral (especially if the Fed does something similar on Dec. 19).
Even if the economy does better than I expect, the latest revelation that the output gap is not closed after all, and that GDP revisions have uncovered some previously hidden slack, then time is on the bank’s side — and that goes for the hawks on the Council as well.
It is little wonder then that the Canadian dollar lost a half-cent following the release of the press statement, the two-year GoC yield melted by six basis points and the OIS market took the odds of a Jan. 9 rate hike down to nearly 40 per cent from 55 per cent.
In other words, there is more room for the Bank of Canada to be removed from the picture, with the two jobs reports between now and then likely to tip the balance. My bet is that the bank is done, period.