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BOC Clings to Tightening Bias as Risks Escalate

Don Curren January 9, 2019

The Bank of Canada held its policy rate steady at 1.75% and issued a policy statement that reaffirmed the need for interest rates to move higher despite acknowledging slowing consumption spending, weaker-than-expected housing investment and lower-than-expected oil prices.

While the statement signaled a shift to the policy sidelines in the near term, it was perhaps not as decidedly dovish as some market players had expected.

The loonie gained ground against the US dollar in the immediate aftermath of the statement’s release Wednesday morning, but quickly relinquished those gains. An earlier advance against the broadly softening US dollar meant the Canadian unit is still higher than late Tuesday.

The Bank’s policy statement, its first of eight in 2019, said the Governing Council continues to judge that “the policy interest rate will need to rise over time into a neutral range to achieve the inflation target.”

“The appropriate pace of rate increases will depend on how the outlook evolves, with a particular focus on developments in oil markets, the Canadian housing market, and global trade policy,” it said.

The Bank said the drop in global oil prices “has a material impact on the Canadian outlook, resulting in lower terms of trade and national income.”

The statement conceded that consumption spending and housing investment have been weaker than expected “as housing markets adjust to municipal and provincial measures, changes to mortgage guidelines, and higher interest rates.”

The Bank projects real GDP will grow by 1.7% in 2019, 0.4 percentage points slower than its October outlook. “This revised forecast reflects a temporary slowing in the fourth quarter of 2018 and the first quarter of 2019. This will open up a modest amount of excess capacity, primarily in oil-producing regions,” it said.

Core inflation measures remain clustered close to the Bank’s 2% target, the statement said. “CPI inflation is projected to edge further down and be below 2% through much of 2019, owing mainly to lower gasoline prices.”

The central bank had raised borrowing costs five times since July 2017, when it shifted abruptly to a tightened bias after maintaining a neutral stance for more than two years.

The Bank shifted almost equally abruptly to a more neutral stance on policy at its last announcement date Dec. 5, acknowledging data suggested economic momentum was dwindling heading into the fourth quarter.

Data released since then have tended to support the narrative of a slowing domestic economy. Statistic Canada’s Labor Force Survey for December, released on Jan. 4, pointed to soft wage growth that month, a factor that will tend to restrain inflation going forward.

By this week, the Overnight Index Swaps market was pricing in virtually no tightening over the next 12 months.

Volatility in both equity and fixed income markets of late reflect expectations among many market participants believe North American economies face slowing growth, or possibly even recession, in the coming months.

Bottom Line: The Bank of Canada is clinging to the notion that interest rates will need to continue increasing in the coming months to keep inflation at its targeted 2% level, but also sees many factors that threaten domestic growth and inflation. The Canadian dollar rallied a bit after the statement, which likely fell short of some expectations of its potential dovishness, but broader US dollar weakness will likely remain the key driver of the USD/CAD pair in the near term.

Don Curren
Content Editor and Market Strategist
dcurren@cambridgefx.com
@dbcurren

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