BoC fore­cast takes darker tone

Oil is only the dark­est of the clouds ob­scur­ing Bank of Canada’s rate path

The Recorder & Times (Brockville) - - BUSINESS - KEVIN CARMICHAEL

In Oc­to­ber, the Bank of Canada said it could fi­nally see home on the hori­zon. Then a storm rolled in.

Canada’s cen­tral bank left its bench­mark in­ter­est rate un­changed at 1.75 per cent on Dec. 5, and it seems likely the pause will last longer than many had ex­pected just a day ear­lier.

Neg­a­tives out weigh pos­i­tive sin the Bank of Canada’s new pol­icy state­ment, a shift from Oc­to­ber, when Gover­nor Stephen Pol oz and his deputies raised in­ter­est rates a quar­ter point. The big­gest con­cern is oil, an im­por­tant source of ex­port in­come. Pol­icy makers had been hold­ing out hope that Cana­dian prices might re­cover some­what. Now, they say the des­per­ate sit­u­a­tion in Al­berta likely means the en­ergy in­dus­try’s con­tri­bu­tion to eco­nomic growth will be “ma­te­ri­ally weaker” than ex­pected only a cou­ple of months ago.

The darker tone caught traders by sur­prise. The value of the Cana­dian dol­lar plunged, and the prices of fi­nan­cial as­sets tied to short-term in­ter­est rates im­ply that the of­fi­cial bor­row­ing rate will re­main un­changed for the re­main­der of the win­ter at least. At the start of the week, those mar­kets were pre­dict­ing a quar­ter-point in­crease in Jan­uary.

“The tim­ing of the next few hikes could be de­layed,” Sébastien Lavoie, chief economist at Lau­ren­tian Bank Se­cu­ri­ties, ad­vised his clients in an email. “We con­tinue to project the overnight rate tar­get to end 2019 at 2.25 per cent, but the next hike may only oc­cur in the spring or sum­mer of 2019.”

The cen­tral bank’s Oc­to­ber out­look was based on a price for West­ern Cana­dian Se­lect of about US$35 per bar­rel, the pre­vail­ing price at the time. Pol­icy makers said then that there was a chance prices would rise once idled re­finer­ies got back to work. In­stead, con­di­tions wors­ened. The price of WCS cur­rently is around $30, but only be­cause Rachel Not­ley, the Al­berta premier, or­dered the prov­ince’s big­gest oil com­pa­nies to curb pro­duc­tion.

“Oil prices have fallen sharply since the Oc­to­ber Mon­e­tary Pol­icy Re­port, re­flect­ing a com­bi­na­tion of geopo­lit­i­cal devel­op­ments, un­cer­tainty about global growth prospects, and ex­pan­sion of U.S. shale oil pro­duc­tion,” the cen­tral bank said, adding that Cana­dian prices are even weaker be­cause of “trans­porta­tion con­straints” and higher in­ven­to­ries.

“In light of these devel­op­ments and as­so­ci­ated cut­back in pro­duc­tion, ac­tiv­ity in Canada’s en­ergy sec­tor will likely be ma­te­ri­ally weaker than ex­pected,” the state­ment said.

Oil is only the dark­est of clouds that ob­scure the cen­tral bank’s path back to a more neu­tral pol­icy set­ting, which it de­fines as a rate be­tween 2.5 per cent and 3.5 per cent, the range at which bor­row­ing costs nei­ther help nor im­pede eco­nomic growth.

A re­turn to that the­o­ret­i­cal place was be­gin­ning to seem pos­si­ble for the first time since the Great Re­ces­sion.

The econ­omy had been con­sis­tently strong for a cou­ple of years; it grew three per cent in 2017, and still was grow­ing at an an­nual rate of two per cent in the third quar­ter, which is about as fast as the cen­tral bank es­ti­mates the econ­omy can grow with­out trig­ger­ing in­fla­tion. With the job­less rate at the low­est level in at least 40 years, pol­icy makers made a point of say­ing that they con­tinue to be­lieve that in­ter­est rates will need to rise to a “neu­tral range” if they are to stay ahead of in­fla­tion.

But the tim­ing is now in doubt be­cause devel­op­ments this au­tumn mostly have been neg­a­tive. Apart from oil, the Bank of Canada ob­served that in­di­ca­tors sug­gest that the econ­omy had “less mo­men­tum go­ing into the fourth quar­ter,” that U.S. Pres­i­dent Don­ald Trump’s trade wars are “weigh­ing more heav­ily on global de­mand,” and that many of the world’s big­gest economies sud­denly are strug­gling.

That sen­ti­ment jibes with the fear that has gripped fi­nan­cial mar­kets this au­tumn. Louis Va­chon, chief ex­ec­u­tive of Canada’s sixth-big­gest lender, told me in an in­ter­view on Nov. 7 that he had turned cau­tious be­cause he felt the econ­omy was slow­ing. “We’re late in the busi­ness cy­cle,” he said.

Pol­icy makers may also have a tech­ni­cal rea­son to take a break from rais­ing in­ter­est rates: we might be poorer than we thought.

New es­ti­mates of gross do­mes­tic prod­uct sug­gest the econ­omy is smaller than in pre­vi­ous es­ti­mates. That’s im­por­tant be­cause it means there could be less pres­sure to raise in­ter­est rates. “Down­ward historical re­vi­sions by Sta­tis­tics Canada to GDP, to­gether with re­cent macroe­co­nomic devel­op­ments, in­di­cate there may be ad­di­tional room for non-in­fla­tion­ary growth,” pol­icy makers said. They promised a fi­nal de­ter­mi­na­tion when they up­date their eco­nomic out­look in Jan­uary.

The lat­est as­sess­ment of the state of play by Canada’s cen­tral bankers wasn’t en­tirely dreary. They ex­pressed con­fi­dence that non-en­ergy in­vest­ment would “strengthen” in the months ahead, sug­gest­ing an im­por­tant eco­nomic en­gine will con­tinue to hum.

Oil not­with­stand­ing, data sug­gest most in­dus­trial com­pa­nies are strug­gling to keep up with new or­ders and will need to add cap­i­tal if they want to grow. The sign­ing of the new North Amer­i­can trade agree­ment makes the fu­ture more cer­tain, and the Trudeau gov­ern­ment’s prom­ise to cut taxes on in­vest­ment and re­duce reg­u­la­tion should make Canada more com­pet­i­tive, the cen­tral bank said. Cor­po­rate prof­its also are near record lev­els, so com­pa­nies have the means to ex­pand if greed trumps fear.

Still, there is no deny­ing that the Bank of Canada is more cau­tious than it was a month or so ago. It con­cluded its state­ment by say­ing the pace of in­ter­est-rate in­creases will be de­ter­mined by a “num­ber of fac­tors,” in­clud­ing the ef­fect of higher bor­row­ing costs on house­hold spend­ing, the trade wars, the “per­sis­tence” of the oil-price shock, and the cen­tral bank’s “as­sess­ment of the econ­omy’s ca­pac­ity.”

That’s a longer list than last time.

CP FILES

Neg­a­tives out­weigh pos­i­tives in the Bank of Canada’s new pol­icy state­ment, a shift from Oc­to­ber, when Gover­nor Stephen Poloz and his deputies raised in­ter­est rates a quar­ter point.

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