Bank of Canada Holds Rates Amid Heightened Trade Tensions

Canada’s key lending rate remained unchanged for the sixth straight meeting today, with the Bank of Canada saying the country’s outlook is “clouded” by trade uncertainty.

The overnight target rate remains at 1.75%, where it has been since October 2018 when rates last fell 25 bps.

“Recent data show the Canadian economy is returning to potential growth. However, the outlook is clouded by persistent trade tensions,” reads the bank’s press release. “Taken together, the degree of accommodation being provided by the current policy interest rate remains appropriate.”

With global financial conditions easing, the BoC lowered its 2019 global growth forecast to 3% from 3.2%. In Canada, the bank said it looks like second-quarter growth will come in higher than expected (with a forecast of 2.3% vs. 1.3% previously), resulting in real GDP growth for 2019 of 1.3% and around 2% in 2020 and 2021.

Housing Market Has Evolved “As Expected”

On housing, the BoC statement said the housing market is stabilizing nationally, “although there are still significant adjustments underway in some regions.” It added that a “material decline” in longer-term mortgage rates is also supporting housing activity.

During a press conference that followed the morning rate decision, BoC Senior Deputy Governor Carolyn Wilkins said the housing market has “evolved as expected at the national level.”

She noted there are signs the housing market in the Greater Toronto Area is improving, while home prices in B.C. continue to move to “more sustainable levels.” In Alberta, Wilkins said the market is continuing to adjust to lower oil prices.

Trade is the Wildcard

The BoC made clear that growing global trade conflicts, including between the U.S. and China, and geopolitical tensions pose the greatest threat to global economic stability.

Combined, these global risks are expected to cut Canada’s GDP by as much as 2% in 2021, said Wilkins.

Poloz cautioned that should a worst-case scenario play out on the trade front, there are limits to how monetary policy can be used to counter its effects.

“The bond market is telling us there’s a preoccupation with downside risks that could bring rates down substantially,” he said. “Understanding the shock is important. We shouldn’t go into this assuming that central banks can somehow fix this if this is what occurs.”

Will the Bank of Canada Eventually Cut Rates?

Despite growing rate cut expectations in recent months and indications that the U.S. is about to embark on monetary policy easing, Poloz gave no such signals on this side of the border.

The BoC Governor noted there are sufficient headwinds in the economy combined with positive economic data to keep rates where they are. “Until such time as those headwinds worsen or dissipate, then we are content with today’s setting of interest rates,” he said.

A reporter asked Poloz if he’d consider a precautionary, or “insurance,” rate cut given that trade risks are “unbalanced.”

Poloz replied that it’s technically not possible to balance risk around trade threats, noting it would come down to the odds of positive or negative outcomes. “I’m not comfortable making up probabilities like that,” he said.

He conceded that if the bank believed the risks were unbalanced, the forecast would “tilt differently.” That would “change inflation expectations and open up discussion to appropriate rate response,” he said.

A Dovish Tone

Overall, the bank’s policy statement was “more dovish than expected,” according to Josh Nye, senior economist at RBC Economics Research.

“The BoC didn’t move explicitly to an easing bias (unlike the Fed and ECB) but sounded more concerned about ‘persistent trade tensions’ that are clouding the outlook,” he noted. “Poloz and Co. still don’t appear to be in any rush to lower rates alongside the Fed…but markets seem justified in thinking the BoC’s next move is more likely to be down than up.”

The Federal Reserve is now overwhelmingly expected to cut rates by 25 bps at its next meeting on July 31.

In Canada, OIS swap markets are pricing in a 44% chance of a rate cut by the end of the year and a 65% chance within the next nine months.