A greater-than-expected slowdown in global economic activity has triggered a slowdown in the pace of interest rate normalization by many central banks. In response to these central bank policy changes and perceived progress in U.S.-China trade talks, global financial conditions and stock market sentiment have improved, pushing up oil and other commodity prices.

Oil prices have risen since January in response to improved market sentiment, a greater-than-expected output cut in Saudi Arabia and risks of falling production in Iran, Venezuela and Libya. In its projection, the Bank assumes that the prices of Brent and WTI oil will remain close to their recent average levels. Uncertainty around the future path for global oil prices, however, remains elevated. The most important considerations relate to OPEC policy and geopolitical risks to production. As well, U.S. shale output could increase at a faster pace than expected.

In Canada, growth during the first half of 2019 is now expected to be slower than was anticipated in the January Monetary Policy Report (MPR). In another very dovish statement, the Bank of Canada acknowledged this morning that the slowdown in the Canadian economy has been more profound and more broadly based than it had expected earlier this year. The Bank had forecast weak exports and investment in the energy sector and a decline in consumer spending in the oil-producing provinces. However, as indicated by the mere 0.1% quarterly growth in GDP in the fourth quarter, the deceleration in activity was far more troubling. Investment and exports outside the energy sector have been negatively affected by trade policy uncertainty and the global slowdown. Weaker-than-anticipated housing and consumption also contributed to the downturn.

As was unanimously expected, the Bank maintained its target for the overnight rate at 1-3/4% for the fourth consecutive time. As well, the Bank dropped any reference to future rate hikes, bringing its policy in line with the Federal Reserve and other major industrial central banks.
“The Bank expects growth to pick up, starting in the second quarter of this year. Housing activity is expected to stabilize given continued population gains, the fading effects of past housing policy changes, and improved global financial conditions. Consumption will be underpinned by strong growth in employment income. Outside of the oil and gas sector, investment will be supported by high rates of capacity utilization and exports will expand with strengthening global demand. Meanwhile, the contribution to growth from government spending has been revised down in light of Ontario’s new budget.”
Overall, the Bank projects real GDP growth of 1.2% in 2019 and around 2% in 2020 and 2021. This forecast implies a modest widening of the output gap, which will be absorbed over the projection period. Inflation is close to the 2% central bank target.

The central bank clearly stated that given all of these economic conditions, an accommodative policy interest rate continues to be warranted. The policy statement added that the Governing Council “will continue to evaluate the appropriate degree of monetary policy accommodation as new data arrive. In particular, we are monitoring developments in household spending, oil markets, and global trade policy to gauge the extent to which the factors weighing on growth and the inflation outlook are dissipating”.

Bottom Line: The Bank of Canada has revised down its estimate of the neutral nominal policy rate. The neutral rate is defined as the sum of two components: i) the real rate that is consistent with output at its noninflationary potential level, and ii) 2% to account for the target inflation rate. The Bank now estimates the neutral rate to be about a quarter percentage point lower than assessed in April of last year, in a range of 2.25% to 3.25%. The midpoint of the range for potential output growth is now estimated to be slightly lower than in the April 2018 MPR, at 1.8% on average between 2019 and 2021 and at 1.9% in 2011. It is likely that these reassessments are consistent with unchanged policy interest rates for the remainder of this year.

Housing Market Details in the April Monetary Policy Report
While housing is expected to stabilize at the national level, the Bank is aware of the risks to the outlook, particularly in the Greater Vancouver Area. For instance, the effects on growth of the revised B-20 guideline are expected to dissipate in many markets, although they could persist longer in areas with high house prices and that have been subject to other changes to housing policies. The stabilization of expectations for house prices in British Columbia and Ontario may indicate a forthcoming stabilization and subsequent increase in resale activity (see Chart 13 below).
The changes to local and provincial policies to address speculation, combined with the B-20 revisions, are having more pronounced effects in the Greater Vancouver Area (GVA) than in the Greater Toronto Area. Thus, while stabilization of activity is expected this year in the base-case projection, there is a risk that it could be delayed in the GVA.

Meanwhile, ongoing challenges in the oil industry are expected to continue to weigh on the Alberta housing market. In contrast, a strong economy and investor interest are expected to boost the market in Montréal.

The First-Time Home Buyer Incentive introduced in the 2019 federal budget is expected to support housing demand and may also lead to improving sentiment in the housing market. However, delays in purchases by homebuyers who want to take advantage of the new measure could influence the timing of resale activity in 2019.

After declining for two years, residential investment is expected to expand modestly in 2020 and 2021. Given the trend reduction in housing affordability, construction of multi-unit residences is expected to resume its trend increase to meet demand for less-expensive homes.

In a very dovish statement, the Bank of Canada acknowledged this morning that the slowdown in the Canadian economy has been deeper and more broadly based than it had expected earlier this year. The Bank had forecast weak exports and investment in the energy sector and a decline in consumer spending in the oil-producing provinces in the January Monetary Policy Report. However, as indicated by the mere 0.1% quarterly growth in GDP in the fourth quarter, the deceleration in activity was far more troubling. Consumer spending, especially for durable goods, and the housing market were soft despite strong jobs growth. Both exports and business investment were also disappointing. Today’s Bank of Canada statement said, “after growing at a pace of 1.8 per cent in 2018, it now appears that the economy will be weaker in the first half of 2019 than the Bank projected in January.”

As was unanimously expected, the Bank maintained its target for the overnight rate at 1-3/4% for the third consecutive time and dropped its earlier reference for the need to raise the overnight rate in the future to a neutral level, estimated at roughly 2-1/2%. The Bank also added an assertion that borrowing costs will remain below neutral for now and “given the mixed picture that the data present, it will take time to gauge the persistence of below-potential growth and the implications for the inflation outlook. With increased uncertainty about the timing of future rate increases, the Governing Council will be watching closely developments in household spending, oil markets, and global trade policy.”

At the same time, Governor Poloz seems reluctant to abandon entirely the idea that the next step is likely higher — making him a bit of an outlier among industrialized economy central bankers.

We are left with the view that the Bank is unlikely to hike interest rates again this year. The global economy has slowed more than expected and central banks in many countries, including the U.S., have moved to the sidelines. Market interest rates have already dropped reflecting this reality.
According to Bloomberg News, “swaps trading suggests investors are giving zero probability that the Bank of Canada will budge rates, either higher or lower, from here. The Canadian dollar extended declines after the decision, falling 0.7 percent to C$1.3438 against the U.S. currency at 10:04 a.m. Yields on government 2-year bond dropped 6 basis points to 1.68 percent.”

February Cold Chills Toronto and Vancouver Housing Markets While Montreal Continues Strong.

In separate news, local realtor boards reported this week that recent housing market patterns continued in February. Resale housing activity fell last month to its lowest level for a February since 2009 in both Vancouver and Toronto, while home sales ramped up in Montreal, marking four years of continuous growth.

The month-over-month declines in Vancouver and Toronto were substantial. Home resales dropped by nearly 8% (on a preliminary seasonally-adjusted basis) in Toronto and by more than 7% in Vancouver. Soft demand in Vancouver kept prices under downward pressure in what has been a buyers’ market. Vancouver’s composite MLS House Price Index (HPI) is now down 8% from its June 2018 peak. And the correction probably isn’t over.
In Toronto, the MLS HPI in February was still 2.3% above its level a year ago, though it has decelerated in the past couple of months from 3.0% in December.

Blasts of bad weather can easily exaggerate demand weakness in winter when markets are at their seasonal low point. However, Montrealers certainly seemed impervious to the weather.

Quebec’s real estate broker association reported home sales in metropolitan Montreal rose 8% in February compared with the same month last year. As well, average residential prices increased 4.9% in metro Montreal and 6.1% on the island of Montreal.
More complete housing data will be available mid-month when the Canadian Real Estate Board releases its February report.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres
drcooper@dominionlending.ca

The Bank of Canada left the overnight benchmark policy rate at 1-3/4%, as expected. In another dovish statement, the Bank of Canada acknowledged a slowdown in global economic activity and highlighted that oil prices are roughly 25% lower than what they had assumed in the October Monetary Policy Report (MPR). The lower prices primarily reflected sustained increases in U.S. oil supply and increased worries about global demand, especially in light of a potential U.S.-China trade war (see oil chart below).

The Bank also commented that these worries had been mirrored in bond and stock markets. Credit spreads off Treasuries have widened, and stock markets have sold off around the world (see chart below). Equity prices and bond yields have declined in the face of market unease over global growth. Volatility has risen, and corporate credit spreads have widened sharply. A tightening of corporate credit conditions is particularly evident in the North American energy sector reflecting the decline in oil prices.

Weak oil prices negatively impact the Canadian economic outlook and “transportation constraints and rising production have combined to push up oil inventories in the west and exert even more downward pressure on Canadian benchmark prices. While price differentials have narrowed in recent weeks following announced mandatory production cuts in Alberta, investment in Canada’s oil sector is projected to weaken further.”

The Bank acknowledged that the economy is running close to potential, unemployment is at a 40-year low and trade will likely improve with the weak dollar, the trade deal with Mexico and the U.S. (now dubbed “CUSMA”) and federal tax measures to target investment. Nevertheless, consumer spending and housing investment “have been weaker than expected as housing markets adjust to to municipal and provincial measures, changes to mortgage guidelines, and higher interest rates. Household spending will be dampened further by slow growth in oil-producing provinces.” The contribution to average annual real economic growth from housing investment has been revised down to -0.1% this year from the +0.1% forecast in October.

The Bank of Canada revised down its forecast for real GDP growth in 2019 to 1.7%–0.4 percentage points lower than the October outlook. According to the Bank, “This will open up a modest amount of excess capacity, primarily in oil-producing regions. Nevertheless, indicators of demand should start to show renewed momentum in early 2019, leading to above-potential growth of 2.1% in 2020.”
Inflation remains close to 2%, the central bank’s target, having fallen to 1.7% in November, due to lower gasoline prices. While low gasoline prices will depress inflation this year, the weak Canadian dollar will have an offsetting impact on the CPI. On balance, the bank sees inflation returning to around 2% by late this year.

Considering all of these factors, the Governing Council continues to judge that the benchmark policy rate will need to rise over time to 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.”

Bottom Line: The Bank of Canada for the first time admits in today’s MPR that the slowdown in the housing market has been more dramatic than the Bank’s staff had expected. The January MPR states, “provincial and municipal housing market policies, the tighter mortgage finance guidelines and higher mortgage rates continue to weigh on housing activity. Slowing of activity in some markets has been associated with less speculative activity. As a result, it is difficult to evaluate the sensitivity of non-speculative demand to the various policy changes. Monthly indicators have signalled that spending on housing likely contracted again in the fourth quarter. Weaker-than-expected housing activity in recent months and staff analysis suggest that the combined effect of tighter mortgage guidelines and higher interest rates has been larger than previously estimated. The Bank will continue to monitor developments in housing markets to assess how construction is adjusting to the shift in demand toward lower-value units.”

The Bank see less urgency to raise interest rates as the economy copes with slumping oil prices and weak housing markets. The five interest rate hikes since mid-2017 are having a more substantial impact on spending than the Bank expected. A short-term pause in rate hikes is now likely. The economy slowed considerably in the fourth quarter of last year, which will continue in the first quarter of this year owing to the decline in oil prices and the Alberta government’s implemented oil production cuts. While it is unlikely that the Bank is finished its tightening this cycle, expect rates to remain steady until we see solid evidence of a rebound in the oil sector and in housing as interest-rate sensitivity of Canadians is at historical highs.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

As was universally expected, the Bank of Canada’s Governing Council held overnight interest rates steady at 1-3/4% as it heralded a weaker outlook for the Canadian economy. The dovish tone in today’s Bank of Canada statement is in direct contrast to its attitude when it last met on October 24. Since that time, the global economy has moderated, and oil prices have fallen sharply. Troubling prospects for Alberta’s energy sector have weighed on the economy as the U.S. has expanded shale oil production. Benchmark prices for “western Canadian oil–both heavy and, more recently, light–have been pulled down even further by transportation constraints and a buildup of inventories”. The Notley government in Alberta ordered production cuts this week leading the Bank to conclude that Canada’s energy sector will be “materially weaker” than expected.
The Canadian economy grew at a 2% annual rate in the third quarter, mainly in line with the Bank’s expectation, however, September data suggest significantly less momentum going into Q4. The biggest disappointment was the plunge in business investment, which likely reflected trade uncertainty (see chart below). Business investment outside of the oil sector is likely to improve with the signing of the new trade agreement USMCA, the new federal tax measures to improve capital depreciation write-offs, and ongoing capacity constraints.

Household credit appears to be stabilizing following a significant slowdown in recent months. However, the rise in interest rates this year has had a more substantial impact on credit-sensitive spending than many had expected. For example, plunging car sales add to evidence that higher borrowing costs are dampening economic activity possibly to a more significant extent than the central bank expected. Light vehicle sales dropped 9.4% in November, the most since 2009. As well, Bank of Canada data show growth in residential mortgages decelerated to 1.4% in September on an annualized three-month basis, the weakest pace since 1982.
The Bank has raised borrowing costs five times since July 2017. New home building declined for the third consecutive quarter, down an annualized 5.9% in Q3. Moreover, according to the Toronto Real Estate Board (TREB), Toronto’s housing market posted its biggest monthly sales decline since March while prices remained little changed. Sales in Canada’s largest city fell 3.4% in November from the previous month TREB reported today (see chart below).

The housing market in the Toronto region has been stabilizing after a slowdown in sales and prices earlier this year amid more stringent mortgage-lending rules. The market picked up its pace through the summer, though sales have declined for the third month in a row.
The drop in sales could in part be attributed to a decline in new listings, which fell 26% year-over-year. “New listings were actually down more than sales on a year-over-year basis in November,” Garry Bhaura, the president of the board, said in a statement. “This suggests that, in many neighbourhoods, competition between buyers may have increased. Relatively tight market conditions over the past few months have provided the foundation for renewed price growth.”
Here is a sampling of other factors that highlight some of the headwinds confronting the Canadian economy:
Economic data have been coming in below expectations according to Citibank’s Surprise Index, which tracks the difference between market expectations for economic indicators and their actual values. This index has trended downward since last summer and has been below zero since mid-October–around the time of the Bank of Canada’s last Monetary Policy Report (MPR) and the most recent rate hike.

The Macdonald Laurier Institute’s Leading Indicator fell 0.1% in October. The composite gauge’s first decline since January 2016 was primarily driven by a pullback in S&P/TSX Composite Index, which fell 6.5% on the month, as well as marked decreases in commodity prices.

As well, inflation pressures have diminished. For example, gasoline prices have tumbled by about 25 Canadian cents back toward a dollar a litre since October. The latest policy statement says, “CPI inflation, at 2.4% in October, is just above target but is expected to ease in coming months by more than the Bank had previously forecast, due to lower gasoline prices. Downward historical revisions by Statistics Canada to GDP, together with recent macroeconomic developments, indicate there may be additional room for non-inflationary growth. The Bank will reassess all of these factors in its new projection for the January MPR.”
Bottom Line: “Governing Council continues to judge that the policy interest rate will need to rise into a neutral range to achieve the inflation target,” the bank said in the statement, adding the appropriate pace of increases will depend on 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 bank said.
As recently as October, investors were expecting at least three more rate hikes in 2019. Currently, those expectations have lessened to no more than two. The Bank had previously estimated the “neutral” range for overnight rates at between 2.5% and 3.5%. Today’s more dovish statement might well indicate that rate hikes over the next year will be to levels well below this neutral range.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

As was universally expected, the Bank of Canada’s Governing Council hiked overnight rates this morning by 25 basis points taking the benchmark yield to 1-3/4%. This marked the fifth rate increase since the current tightening phase began in July 2017 (see chart below). The central bank stated it would return the overnight rate to a neutral stance, dropping the word ‘gradually’ that was used to describe the upward progression in yields since this process began. Market watchers will certainly note this omission. For the first time in years, the Bank has acknowledged it expects to remove monetary stimulus from the economy entirely.
So what is the neutral overnight rate? According to today’s Monetary Policy Report (MPR), “the neutral nominal policy rate is defined as the real rate consistent with output sustainably at its potential level and inflation equal to target, on an ongoing basis, plus 2% for the inflation target. It is a medium- to long-term equilibrium concept.” For Canada, the neutral rate is estimated to be between 2.5% and 3.5%, which implies that at a minimum, three more 25 basis point rate hikes are likely over the next year or so.

The Bank of Canada emphasized that the global economic outlook remains solid and that the U.S. economy is particularly robust, but is expected to moderate as U.S.-China trade tensions weigh on growth and commodity prices. The new U.S.-Mexico-Canada Agreement (USMCA) eliminated a good deal of uncertainty for Canadian exports, which will reignite business confidence and investment. Business investment and exports have been of concern in recent quarters, and the Bank is now looking towards a resurgence in these sectors, augmented by the recently-approved liquid natural gas project in British Columbia.
A continuing concern, however, is the decline in Canadian oil prices. Western Canada Select (WCS), a local blend that represents about half of Canada’s crude oil exports, has declined about 60% since July as global oil prices have risen (see chart below). WCS plunged below US$20 a barrel last week posting the biggest discount to West Texas Intermediate (WTI) on record in Bloomberg data back to 2008. WCS generally tracks heavy oil from Canada, which typically trades at a discount to WTI because of quality issues as well as the cost of transport from Alberta to the refineries in the U.S.
Canadian pipelines are already filled to the brim. The inability of the Canadian oil industry to build a major pipeline from Alberta to either the U.S. or the Pacific Ocean is increasingly dragging down domestic oil prices. Oil-by-rail shipments to the U.S. are at an all-time high, but this is an expensive and potentially unsafe option and precludes Canadian oil exports to China and Japan.

An even broader concern is the impact of higher interest rates on debt-laden consumers. The Bank is well aware of the risks, as the MPR cited that “consumption is projected to grow at a healthy pace, although the pace of spending gradually slows in response to rising interest rates… Higher mortgage rates and the changes to mortgage guidelines are affecting the dynamics of housing activity. Housing resales responded quickly to the new mortgage guidelines, and the level of resale activity is expected to continue on a lower trajectory than before the changes. New home construction is shifting toward smaller units, although stronger population growth is estimated to raise fundamental demand for housing.”
Household credit growth has slowed, and the share of new mortgages with high loan-to-income ratios has fallen. The ratio of household debt to income has levelled off and is expected to edge downward (see chart below).

Low-ratio mortgage originations declined by about 15% in the second quarter of 2018 relative to the same quarter in 2017 (see charts below). The MPR shows that “while activity fell for all categories of borrowers, the drop was more pronounced for those with a loan-to-income ratio above 450%, leading to a decline in the number of new highly indebted households”.

Bottom Line: The Bank of Canada believes the economy will grow about 2% per year in 2018, 2019 and 2020, in line with their upwardly revised estimate of potential growth of 1.9%. The Bank asserts that mortgage tightening measures of the past two years have “reduced household vulnerabilities,” although the “sheer size of the outstanding debt means that vulnerability will persist for some time”. That is Bank of Canada doublespeak. What it means is expect three more rate hikes by the end of next year.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

As expected, the Bank of Canada held its key overnight rate this morning at 1.5%, asserting that July’s surprising spike in CPI inflation to 3% was in large part because of a jump in airfares. The Bank expects inflation to move back towards 2% in early 2019, as the effects of past increases in gasoline prices dissipate. The Bank’s core measures of inflation remain firmly around 2%, consistent with an economy that has been bumping up against full capacity for some time. Wage growth, as well, remains moderate.

Incoming information on the global economy is consistent with the Bank’s forecast in the July Monetary Policy Report (MPR). The U.S. economy has been particularly strong, growing at a 4.2% rate in the second quarter. This compares to Canada’s growth rate of 2.9% last quarter, which follows a 1.4% pace of economic expansion in Q1. Second quarter growth in the U.S. was boosted by strong consumer spending and business investment. In Canada, third quarter growth is expected to slow temporarily, mainly because of fluctuations in energy production and exports.

Indeed, this morning, Statistics Canada reported that Canada’s trade deficit all but disappeared. A sharp export gain to the U.S. combined with a decline in imports took Canada’s overall merchandise trade deficit to its lowest level since December 2016.

Canada’s merchandise trade surplus with the U.S., targeted by President Donald Trump in NAFTA negotiations, grew to the widest in a decade. Stats Canada said that gains in global exports were led by automobiles and energy, almost all of which were bound for the U.S. Crude oil led the energy gains as prices rose 9.4% in July. The import decline was driven by aircraft and metal ores.

These figures are likely to impact the resumption of bilateral talks in Washington regarding NAFTA, as the Trump administration has negotiated a new deal with Mexico and has threatened to leave Canada out and impose stiff auto tariffs if Prime Minister Justin Trudeau’s government does not make concessions, especially on dairy supply management and dispute mechanisms.

The Bank of Canada highlighted that “elevated trade tensions remain a key risk to the global outlook and are pulling some commodity prices lower…The Bank is also monitoring the course of NAFTA negotiations and other trade policy development closely, and their impact on the inflation outlook.”
It was wise of the Bank of Canada to hold its powder dry at today’s policy meeting given the continued uncertainty on the NAFTA front. An agreement on NAFTA would provide the central bank with more comfort in moving ahead with a hiking cycle that has already lifted the benchmark overnight rate four times since mid-2017.

Noting that “activity in the housing market is beginning to stabilize as households adjust to higher interest rates and changes in housing policies”, the Bank reaffirmed that the economy is doing well enough to require higher interest rates in the future to achieve the inflation target. Another rate hike could come as soon as the next policy meeting on October 24th.

It is widely expected that a NAFTA deal will have come to fruition by then, opening the way for the Bank to resume monetary tightening. According to Bloomberg News, “Investors see near-certain odds that by October, the Bank of Canada will raise borrowing costs for the fifth time since the hiking cycle began in July 2017, with as many as two additional increases by mid-2019.”

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres
drcooper@dominionlending.ca

OTTAWA _ The Bank of Canada kept its key interest rate target on hold Wednesday, but hinted that rate hikes could be coming as it noted the Canadian economy was a little stronger than expected in the first quarter.

The central bank held its target for the overnight rate _ a key financial benchmark that influences the prime lending rates at the country’s big banks _ steady at 1.25 per cent.

“Exports of goods were more robust than forecast and data on imports of machinery and equipment suggest continued recovery in investment,” the Bank of Canada said in a statement.

“Housing resale activity has remained soft into the second quarter, as the housing market continues to adjust to new mortgage guidelines and higher borrowing rates. Going forward, solid labour income growth supports the expectation that housing activity will pick up and consumption will continue to contribute importantly to growth in 2018.”

The central bank also said global economic activity remains broadly on track, but added that ongoing uncertainty about trade policies is dampening global business investment and stresses are developing in some emerging market economies.

It noted that recent developments have reinforced its view that higher rates will be warranted to keep inflation near its target, but added that it will take a gradual approach and be guided by the economic data.

“In particular, the bank will continue to assess the economy’s sensitivity to interest rate movements and the evolution of economic capacity,” it said.

Economists had predicted the Bank of Canada would keep its key rate on hold Wednesday, but many have suggested the rate may be headed higher later this year.

The central bank’s decision to keep its trend-setting rate on hold came as inflation sits above the two per cent midpoint of its target range of one to three per cent and core inflation has crept past the two per cent mark for the first time since 2012.

It noted that inflation will likely be a bit higher in the near term than was forecast in its April monetary policy report due to recent increases in gasoline prices, but that it will look through the transitory impact of the fluctuations at the pump.

The central bank has raised its key rate three times since last summer, increases that have prompted the big Canadian banks to raise their prime rates which are used to set the rates charged for variable-rate mortgages and other variable-rate loans.

Its next scheduled interest rate decision is set for July 11 when it will also update its outlook for the economy and inflation in its monetary policy report.

The Bank of Canada is maintaining its trend-setting interest rate as its careful assessment of the timing of future hikes continues amid a backdrop of moderating growth.

The central bank, which kept its rate at 1.25 per cent Wednesday, said slower first-quarter growth of about 1.3 per cent was largely a result of housing markets’ responses to stricter mortgage rules and sluggish exports. The bank had predicted the economy to expand by 2.5 per cent in the first three months of the year.

It’s expecting the economy to rebound in the second quarter with 2.5 per cent growth, in part because of rising foreign demand, to help Canada expand by two per cent for all of 2018. The economy saw three per cent growth in 2017.

“Canada’s economic growth has moderated, and the economy is operating close to capacity,” the bank said in its latest monetary policy report, which was released alongside the rate announcement.

“While a moderation was anticipated, temporary factors … are resulting in sizable short-term fluctuations in growth.”

The bank reiterated it expects further interest-rate hikes to be necessary over time and that it will follow a cautious, data-dependent approach when weighing future decisions.

“Some progress has been made on the key issues being watched closely by governing council, particularly the dynamics of inflation and wage growth,” the bank’s statement said.

“This progress reinforces governing council’s view that higher interest rates will be warranted over time, although some monetary policy accommodation will still be needed to keep inflation on target.”

The bank will also continue to watch the economy’s sensitivity to higher interest rates and how well it builds capacity through investment, which would enable Canada to lift growth beyond what is viewed as its potential ceiling without driving up inflation.

Signs suggest the economy has made some progress in building this capacity, the bank said.

The bank is also keeping a close watch on the evolution of external risks.

Exports and business investment in Canada have been held back by competitiveness challenges and trade-policy uncertainties, which include escalating geopolitical conflicts that risk damaging global expansion, the bank said.

It laid out estimates on the growth impacts on Canada due to tax reforms in the United States, which are expected to lure more investment south of the border. Due to these investment challenges, it predicts Canada’s gross domestic product to be 0.2 per cent lower by the end of 2020.

Exports are also expected to take a hit from reduced investment and trade uncertainties. The bank projects that Canada’s GDP will be 0.3 per cent lower by the end of 2020 due to the negative impacts on exports.

Fiscal stimulus introduced in recent provincial budgets is expected to help offset these effects by adding about 0.4 per cent to Canada’s real GDP by the end of 2020.

Governor Stephen Poloz introduced three rate hikes since last summer in response to an impressive economic run for Canada that began in late 2016. But due, in part, to factors such as mounting trade unknowns, Poloz has not raised the rate since January.

The bank offered an analysis Wednesday of some of the key indicators it’s watching ahead of rate decisions.

On inflation, the bank said temporary downward forces weighing on the rate have largely dissipated. Other transitory factors, including higher gasoline prices and recent minimum wage increases are now expected to raise inflation above the bank’s January predictions.

Canada’s annual pace of inflation in February sped up to 2.2 per cent _ its fastest pace in more than three years _ to creep above the central bank’s ideal target of two per cent. Meanwhile, the average of the agency’s three measures of core inflation, designed to omit the noise of more-volatile items like gasoline, climbed slightly above two per cent for the first time since February 2012.

For wage growth, the bank said despite recent improvements it remains below what would be expected if the economy no longer had slack in its labour force.

On Wednesday, the bank also released new economic forecasts in its monetary policy report.

For 2018, it’s now predicting two per cent growth, as measured by real gross domestic product, compared to its 2.2 per cent prediction in January.

The bank raised its growth projection for 2019 to 2.1 per cent, up from its previous prediction of 1.6 per cent, before easing to 1.8 per cent in 2020.

It noted that these readings would still be slightly above Canada’s estimated potential output for the next three years.

The Bank of Canada kept its key interest rate target on hold as it pointed to a climate of broadening, important unknowns around trade.

In explaining its decision to maintain its benchmark rate at 1.25 per cent, the central bank notes that recent trade policy developments are a key source of uncertainty for the Canadian and global outlooks.

U.S. President Donald Trump recently added threats of steel and aluminum tariffs to an already uncertain context for Canada that includes concerns over NAFTA’s renegotiation and competitiveness following tax-cut announcements south of the border.

The Bank of Canada notes fourth-quarter growth was weaker than expected, largely due to higher imports, and that it’s still assessing impacts on housing markets from new policies, including mortgage rules.

But it says global growth continues to be solid and broad-based, the economy is running near capacity, inflation is close to target and wage growth has improved, although still remains below where many expect it should be.

Governor Stephen Poloz was widely expected to hold off moving the rate because of weaker economic numbers in recent weeks and the expanding trade uncertainty.

Poloz has introduced three rate hikes since last summer, including an increase in January. The moves came in response to an impressive economic run for Canada that began in late 2016.

In the statement Wednesday, the bank reiterated it expects more hikes to be necessary over time, but that the governing council will remain cautious when considering future decisions.

They will continue to be guided by incoming data, such as the economy’s sensitivity to higher rates, the evolution of economic capacity and changes to wage growth and inflation, it said.

The highly anticipated December Labour Force Survey, released this morning by Stats Canada, surpassed forecasts breaking multi-year records. Canada’s jobless rate fell to 5.7% in December, its lowest level in more than 40 years, raising the prospects for a Bank of Canada rate hike possibly as soon as this month. The number of jobs rose by 78,600 bringing the full-year gain to 422,500, the best annual increase since 2002. While most of the jobs in December were part-time, nearly all of the net jobs created in 2017 were in full-time work (+394,000 or +2.7%).

Since September, the country added 193,400 jobs, the largest three-month gain since current records began in 1976. Canadian bond yields and the currency rose sharply in the wake of these data. The loonie surged to over 80.50 cents U.S. According to Bloomberg News, the odds of a rate hike at the Bank of Canada’s next meeting on January 17 soared to 70%, from 40% yesterday, based on trading in the swaps market.

The largest employment gains in December were in Quebec and Alberta. In December, 25,000 more people were employed in finance, insurance, real estate, and rental and leasing, following three months of little change. For the year as a whole, jobs increased by 3.5% in the goods-producing sector and by 2.0% in the services-producing sector.

Actual hours worked in December were 3.1% above year-ago levels, the fastest since 2010. As well, new data show that wages are finally accelerating having been stagnant for much of 2017. Wage gains for permanent employees accelerated to 2.9% year-over-year from 2.7% last month–another closely watched indicator for the Bank of Canada.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres