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Thursday March 8, 2018

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Report

Bank of Canada remains on hold amid global trade policy uncertainty

The policy rate was left at 1.25%, as was widely expected; Global trade policy was said to be an important "and growing" source of uncertainty; We maintain that the Bank of Canada will likely remain on hold for the rest of the year.

The Bank of Canada left its policy rate unchanged at 1.25%. The consensus was for no change and there was only a 12.7% chance (3.2 basis points) priced into the OIS market prior to the decision.

In Bank of Canada's statement:

• The Bank noted that Q4 GDP was slower than expected, largely due to a rise in imports, which was said to "mainly reflect stronger business investment."

• Inflation was said to be near the 2% inflation target, and thus consistent with an "economy operating near capacity."

• The Bank twice repeated that it was monitoring the "economy's sensitivity to higher interest rates." Previous statements made only one reference to the impact of higher rates on the economy.

• Wage growth was said to have "firmed," but remains lower than might have been expected in an economy with no labour slack.

• Global trade policy developments were indicated to be an "important and growing source of uncertainty."

• The Bank maintained a posture tilted toward higher rates "over time", but said that it would take a cautious approach to future policy adjustments.

Implications

We consider today's Bank of Canada statement as cautious, most notably owing to increased trade policy uncertainty. We can't say that the statement was neutral since the Bank maintains an underlying view that the economic outlook is likely to warrant higher rates over time.

Nonetheless, today's policy statement highlighted several factors that have made it challenging to interpret recent data releases and that reinforce our view that the Bank will take a cautious approach to future rate hikes. We maintain that the Bank is likely to remain on the side-lines for the rest of 2018, and that the market is too aggressive with 53 basis points of rate hikes priced in by year end.

On the domestic front, changes to mortgage lending rules and the increase in the minimum wage in Ontario were noted. The forthcoming changes to mortgage lending rules were said to have pulled forward some mortgage borrowing and home purchases into Q4. Hence, the underlying momentum in the housing market is unclear. Meanwhile, the increase in the minimum wage in Ontario, along with temporary factors affecting gasoline prices, and changes to electricity pricing in Ontario in 2017, make it more challenging to observe the underlying trend in inflation.

It will take a few months for trends to become clear. Meanwhile, lags in Canadian data likely mean we won't have clarity until mid-year at the earliest. That said, many of these domestic policy uncertainties were known as of 17 January and the Bank of Canada still chose to hike interest rates by 25 basis points.

The Bank noted that the gain in imports in Q4 "mainly reflected stronger business investment, which adds to the economy's capacity." While we think that the statement is true, we think that it also requires further qualification. Just as impending changes to mortgage lending rules may have brought forward housing activity, we believe that a surge in heavy machinery imports at the end of last year was related to changes to engine emisssion regulations at the start of this year. As a result, there was a notable increase in imports of heavy equipment in Q4. Today's trade data for January demonstrated a sharp decrease in imports of heavy equipment for logging, mining and construction.

It is thus far from clear, in our view, that the increase in imports of machinery and equipment in Q4, represents a more favourable backdrop for business investment. In fact, a survey of business capital expenditure intentions for 2018, released in late February, reflected ongoing caution on the part of firms. Corporate capital expenditures were projected to be down by 0.2% year-on-year in 2018. This would be the fourth straight year of decline in corporate capex.

The Bank also highlighted global policy developments that have led to increased uncertainty. The BoC's did not explicitly reference the ongoing NAFTA negotiations, or US President Trump's announcement of his intention to impose tariffs on imports of steel and aluminium. Nonetheless, trade policy developments were flagged as an "important and growing source of uncertainty" for forecasts of global and Canadian GDP growth.

In it's statement the BoC said that wage growth "remains lower than would be typical in an economy with no labour market slack." To us, this suggests that the Bank continues to believe that there is a greater degree of slack in the job market than the low unemployment rate might suggest. As well, the increase in the minimum wage in Ontario at the start of the year has added some uncertainty to the labour market. While the increase in the minimum wage has resulted in a rather mechanical increase in the wages of some workers, it might have contributed to a sharp decline in part-time employment in January. It will take time to assess the impact of the increase in the minimum wage.

Up next, we await a speech by BoC Deputy Governor Tim Lane tomorrow from Vancouver, British Columbia. Mr. Lane's speech is entitled "Economic Progress Report." The remarks will be the first in a new series of speeches that will follow rate decisions that are not accompanied by a Monetary Policy Report (MPR), nor a press conference. According to the Bank of Canada, the Economic Progress Report (EPR) will "provide insight into the key issues figuring in the deliberations about the rate decision." As the Bank does not release minutes of its policy deliberations, these statements will help to explain more clearly the thinking behind the rate decision.

Bank rate decisions in January, April, July, and October are released alongside a MPR. Economic Progress Reports will follow rate decisions in March, May, September, and December.



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