BOC ‘on hold,’ with little good news in sight

It’s difficult to find anything good to say about the economy at the moment, but Lynn Patterson, the Bank of Canada deputy governor, went to Hamilton on Thursday and gave it try.

Patterson, who joined the central bank in 2013 after making a name for herself on Bay Street, didn’t pretend that things weren’t grim. Gross Domestic Product nearly stalled in the fourth quarter, and the country recorded its widest trade deficit ever in December. There isn’t a shade on L’oreal’s colour spectrum that will disguise that pig.

“Although we figured the economy was in for a detour at the end of last year, that detour may wind up being longer than we had expected,” Patterson said at an event hosted by Hamilton Chamber of Commerce.

That line will reinforce the emerging consensus that the Bank of Canada’s quest for higher interest rates is over.

Not so long ago, bond traders were debating the number of times the central bank would raise interest rates this year: two, three, or four? Now, those who see one increase towards the end of the year are the optimists. Fixed-income prices suggest investors are hedging against the risk of an interest-rate cut, while betting that policy makers are on hold until 2020.

Those are realistic, not pessimistic, bets. Patterson and her colleagues, including Governor Stephen Poloz, left the benchmark interest rate unchanged at 1.75 per cent on Wednesday and said the path to higher borrowing costs was “uncertain.” When that group last met in January, it said it was in no rush to change policy, but that interest rates would still need to rise “over time.” The new policy statement also included an assessment that economic conditions warranted an interest rate below the “neutral range,” which the central bank estimates is 2.5 per cent to 3.5 per cent.

In other words, we might be brushing the ceiling.

“The Bank of Canada is on hold for at least the next six months, if not permanently,” Darcy Briggs, who oversees assets of about $6 billion at Franklin Bissett Investment Management in Calgary, said.

“Against this backdrop, I’d expect the hurdle rate to resume rate hikes to be quite high,” said Sophia Drossos, a former economist at the U.S. Federal Reserve and Morgan Stanley, who now runs her own advisory firm in New York.

Patterson made little attempt to correct such interpretations of the Bank of Canada’s thinking. But she did offer a reminder that an uncertain outlook is different than a negative one. “We still expect Canadian economic growth to pick up later in the year, supported by ongoing strength in employment and rising wages,” she said.

The biggest blow to the economy was delivered by weaker oil prices and the crisis of confidence in the energy industry. That situation prompted the central bank to back away from interest-rate increases at the end of last year. But it’s not what caused policy makers to continue their retreat to the sidelines this week. Patterson said the slowdown in the energy industry so far is “fairly aligned” with the central bank’s low expectations.

The surprise was that so many other economic engines sputtered. Household consumption, real estate, exports, and business investment all stumbled, catching policy makers off guard. In January, the central bank predicted that GDP would expand at an annual rate of 1.3 per cent in the fourth quarter.

Instead, growth slowed to 0.4 per cent. Some analysts think the current quarter will be even worse because the Alberta government ordered oil companies to curb production in order to put a floor under prices.

“It’s going to be squishy for a while,” Briggs said. “Our base case is for a very subdued growth environment.”

The Bank of Canada might be leaning that way, but its job description keeps it from making directional bets too soon. Poloz sees himself as a risk manager; he always is hedging against the possibility that the most obvious scenario could be wrong. Because some of the drivers of Canada’s slump defy easy explanation, it’s possible the economy could get back on track relatively quickly.

Investment probably is being impeded by trade policy; the new North American free-trade agreement remains unratified, and U.S. President Donald Trump’s trade war with China and others has spread fear throughout the global economy. But if uncertainty is weighing on business spending, then it’s reasonable to assume that a resolution of any those situations would spur companies to begin deploying their profits.

Executives might also have delayed investment plans to take advantage of the tax cuts that Finance Minister Bill Morneau announced in October, Patterson said. “If so, we should begin to see a pickup in the first quarter of this year,” she said.

To be sure, Statistics Canada reported late in February that non-residential investment will rise 2.5 per cent in 2019, according to a survey of companies, compared with increases of 2.5 per cent last year and 4.3 per cent in 2017.

Patterson also noted that exports of services surged six per cent in the fourth quarter, suggesting the headline trade numbers could be skewed by higher priced commodities and manufactured goods.

The housing slump was led by an odd plunge in renovations; mortgage credit actually grew in the fourth quarter. “We’ll see what happens with sales once spring rolls around,” Patterson said.

That’s also when we’ ll see where interest rates are headed this year. The Bank of Canada’s next quarterly economic update is scheduled for release on April 24. If there have been no positive surprises by then, they probably won’t be coming soon enough to keep 2019 from being anything but a disappointment.