BoC keeps key rate on hold amid fears over strained NAFTA talks, rising debt

Looming risks seen as catalyst to bank’s ‘considerably more cautious’ move

The Bank of Canada’s decision on Wednesday to maintain its current overnight rate is led by fears over high household debt and souring negotiations around the North American Free Trade Agreement, both of which could restrict inflation growth and delay future rate hikes.

Interest rates were kept at one per cent, a move that was widely expected following rate hikes in July and September. The decision reinforced the more dovish tone adopted by the bank in recent months, running somewhat in contrast to the federal government’s cheery fiscal update released Tuesday.

The bank said a “pronounced” drop in Canadian housing prices, stronger U.S. GDP growth, rising household debt levels and threats by U.S. President Donald Trump’s administration to shred NAFTA are looming risks to the Canadian economy.

Bank of Canada governor Stephen Poloz said Wednesday he had met with several Canadian businesses that have considered investing outside of Canada over fears NAFTA talks could crumble.

In particular, he said many firms are weighing whether they should invest in the U.S. as a hedge against souring negotiations over the treaty; others are considering increasing offshore production capacity rather than exporting from Canada.

“Companies are investing less than they would without the uncertainty around NAFTA,” Poloz said.

In its Monetary Policy Report released Wednesday, the BoC said uncertainties over the Trump administration’s trade policies could cause investment to shrink 0.7 per cent in 2017 and 2018.

The bank’s rate decision comes as Canada, Mexico and the U.S. agreed to extend NAFTA talks to March 2018 after failing to complete negotiations within the year. Reports that the U.S. has tabled several hard-nose policies have caused rumblings that the treaty could be scrapped altogether.

While the bank said threats to terminate NAFTA were a risk to inflation, its rate decision did not account for uncertainty around negotiations. “We simply don’t know enough about what might happen,” Poloz said.

It remains unclear how businesses would react if the treaty were terminated, he said, emphasizing that the Canada-U.S. exchange rate in recent years has often been much wider than the tariffs that would likely fall into place in the absence of the trade deal.

The bank also warned rising Canadian household debt levels were a risk to the economy. Future rate hikes are expected to have an increasingly acute impact on Canadian families, the bank said, as household debts continue to rise.

Household incomes and wages are also expected to rise in the nearterm, but that trend could eventually expose more Canadians to costlier debts, particularly as consumer spending remains robust.

“This would provide a boost to economic activity, but it could further exacerbate the macro-economic and financial vulnerabilities associated with high household indebtedness,” the monetary report said.

Canadian household debt as a percentage of disposable income is among the highest in developed nations, according to data from the Organization for Economic Co-operation and Development (OECD). Canada’s debt-to-disposable income was 175 per cent in 2015, the eighth highest in the group.

The BoC decision also cited overheated housing markets as a risk to growth.

Douglas Porter, the chief economist at BMO Financial Group in Toronto, said in a note to clients that the bank “sounded considerably more cautious." BMO now expects the BoC to hike rates next March, rather than January, and is forecasting a total of three hikes in 2018, down from an earlier estimate of four.