News & Analysis

The Bank of Canada left its policy rate at 5% for a fifth straight meeting today, in line with the broad consensus.

However, given progress on disinflation in the aggregate measures has only just resumed, the question heading into today’s policy decision was never what the Bank would do on rates but instead how it would update its forward guidance in response to the latest round of data. On this front, the Bank’s characterisation of the economy was almost perfectly aligned with our own assessment. It downplayed the strength of the Q4 GDP data, noting that this was largely driven by improved export growth and the economy still effectively stagnated in the second half of the year, meaning the stronger growth reading posed minimal risk to reigniting inflation pressures. The Bank also highlighted that the labour market continues to fall into better balance with job vacancies returning to more normal levels and employment growth struggling to keep pace with overall population increases.

The only deviation from our view came from the Bank’s assessment of inflation conditions, where the emphasis was now seemingly placed on the overall level of inflation as a means to justify holding the policy rate at 5% for a prolonged period of time, as opposed to the highlighting signs of renewed and sustainable disinflation.

This was apparent in the Bank’s policy statement and in Governor Macklem’s inaugural non-MPR press conference even as he highlighted that most of the inflation impulse now stems from shelter– a component broadly outside the BoC’s influence, partially reflective of the higher interest rate environment itself, and discounted by peers like the Federal Reserve. As a result, the BoC’s updated guidance didn’t point towards the possibility of an April rate cut depending on the next round of data as we expected. Instead, it sought to delay any speculation of rate cuts, with Governor Macklem noting that it is “too early to consider lowering the policy rate” within his opening remarks.

Reflecting today’s guidance, we now think the BoC is more likely to delay any decision to cut rates until June 5th, a luxury seemingly afforded to them by the strength of the US data pushing expectations of a cut from the Federal Reserve back to July at the earliest. That said, our updated forecast doesn’t reflect what we think the Bank should do, but what it is likely to do. In our view, all Canadian economic indicators uniformly point towards a inflation cooling on a trend basis.

This should be reflected in the Bank’s April forecasts and in the results of its Q1 business and consumer surveys released a week before the next meeting.

Nevertheless, the BoC now runs the risk of undermining its credibility should it cut in April seeing as it passed up the opportunity to guide markets towards this outcome at today’s meeting. As a result, it will likely use the April decision to setup the normalisation path for the remainder of the year.

In delaying the start of the easing cycle, the BoC is putting the economy at undue risk, raising the probability that it will need to cut rates faster and potentially to a lower terminal rate down the line. This makes for an interesting setup for USDCAD. In the short-term, the BoC’s hawkishness should see the loonie retain its defensive capabilities against broad USD appreciation on the back of higher yields. However, this leaves the loonie susceptible to a more significant downside correction later into the second quarter should the incoming Canadian data deteriorate as a result of the BoC’s hesitancy to ease rates sooner.

Reflecting this, we maintain our short-CAD bias, but note the period of significant depreciation is likely to be delayed until the mid-Q2.

 

 

Author: 

Simon Harvey, Head of FX Analysis

 

 

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