In case you missed it, the BOC delivered its monetary policy decision yesterday, which caused the Loonie to surge across the board. And here are the key highlights that you need to know about.
1. First rate hike in 7 years
As expected, the BOC raised the Overnight Rate by 25 basis points from 0.50% to 0.75%. This is the first rate hike since 2010. And in BOC Governor Poloz’s opening statement for the presser, he explained that the hike was warranted since the BOC’s “confidence in the outlook for the economy and inflation” has been “bolstered” because “Economic data have been encouraging over the past few months, globally and especially for Canada.”
2. Weak CPI due to “temporary” factors
As I noted in my most recent Canadian Economic Snapshot, Canada’s recent CPI data have been rather underwhelming and continue to miss the BOC’s forecasts. Moreover, two of the BOC’s preferred measures for core inflation continue to trend lower.
In its official press statement, the BOC acknowledged this by noting that “CPI inflation has eased in recent months and the Bank’s three measures of core inflation all remain below 2 per cent.”
Moreover, the BOC’s July Monetary Policy Report showed that the BOC downgraded its CPI forecast for Q2 2017 from 1.7% year-on-year to 1.4%. In addition, the BOC further projects that CPI will moderate further by coming in at 1.3% by the end of Q3.
However, the BOC forecasts that CPI will pick up to 1.6% by Q4 and then continue to accelerate after that. Even so, the forecasts for Q4 2017 and Q4 2018 are still lower compared to the original forecasts presented in the April BOC Monetary Policy Report.
Despite all that, the BOC remains pretty optimistic and was quick to point out that the “factors behind soft inflation appear to be mostly temporary.”
And the two “mostly temporary” factors explicitly identified by the BOC were (1) the decline in auto price inflation and (2) the weakening in consumer energy inflation, as can be seen below.
The recent weakness in consumer energy prices “includes, in part, the recent decline in crude oil prices as well as the waning effect of the strong price increases in 2016,” as well as reduced cost of electricity in Ontario.
As for the decline in auto prices, that likely reflects “strong demand and the eff ects of a lower Canadian dollar,” according to the BOC. And the BOC expects the slump to slow down since auto price inflation is “returning close to its historical average in May.”
3. BOC optimistic on growth
The BOC upgraded its GDP growth forecasts for Q2, largely because of stronger exports growth. However, the BOC continues to forecast that GDP growth will moderate further in Q3 and Q4, thanks to the BOC’s forecast that the positive contribution from consumer spending will moderate further.
And as explained in the BOC’s Monetary Policy Report, “Consumption growth will be restrained by elevated levels of household debt and higher longer-term borrowing costs as global long-term yields are projected to gradually rise.”
The BOC isn’t really worried about weaker consumption growth, though, since it expects exports and business investment to pick up the pace.
Moreover, the BOC is confident that the Canadian economy is robust because there has been a broad-based improvement in other goods industries, as well as the service sector, so Canada is no longer as dependent on the energy sector for growth.
4. More rate hikes to come?
Poloz was asked during the presser if the market should expect more hikes this year. And poloz bluntly stated that:
“I’m not going to make a forecast about the interest rate.”
Poloz was also asked if the rate hike was the first step in removing the 50 bps “insurance” from 2015 or the start of a tightening cycle.
And as a refresher, the BOC slashed the Overnight Rate twice in 2015 in order to support the Canadian economy after oil prices slumped pretty hard at the time.
Getting back on topic, Poloz answered by saying that: “I’m hesitating to classify it as either one of those.”
However, Poloz also said the following (emphasis mine):
“The most important thing is the economy clearly no longer need as much as stimulus as we’ve been giving it. But at the same time, we’re letting you know that the world has changed enough in recent years.”
“In the full course of time, I don’t doubt that interest rates will move higher, but there’s no predetermined path.”
It’s therefore pretty clear that the BOC is looking to hike more if the Canadian economy evolves as expected (or better). Moreover, Poloz hinted that the BOC may be in a tightening cycle, and is not just looking to remove the 50 bps “insurance” that was introduced in 2015, when he said that “the world has changed enough in recent years.”
Of course, Poloz gave the usual caveats about monetary policy being data-dependent and that global uncertainty remains high. And Poloz cited Canada’s southern neighbor as the main source of that uncertainty.
Even so, Poloz gave this an optimistic spin by saying the following:
“While uncertainties remain, delays in decision making in the United States seem to have moved some of those concerns more into the background. The Bank’s latest Business Outlook Survey, for example, finds very strong business sentiment, particularly for investment and hiring intentions, despite a lack of clarity about future US policies.
Aside from the rate hike, which was probably priced in already, the BOC also made the case for Canada’s robust economic growth while providing an explanation as to why CPI remains weak and why the BOC thinks that the weak CPI is only temporary.
These rather optimistic views are already rather hawkish signs. However, Poloz also said during the presser that he thinks interest rates will move higher over time, which is an explicit sign of the BOC’s hiking bias. Not only that, Poloz heavily implied that the rate hike may be the start of a hiking cycle and not just a means to remove the 50 bps preemptive rate cuts from 2015. It’s therefore not very surprising why the Loonie reacted as strongly as it did.