As expected, the Bank of Canada left its policy rate unchanged at 1.75%. The Governing Council said that the current policy rate continued to provide the appropriate amount of monetary stimulus. Developments in the energy sector, and the impact of trade tensions on the Canadian economic outlook will be closely monitored.
The policy statement highlighted that global trade tensions are having a "material effect" on the global economic outlook, and have prompted recent dovish shifts by the Federal Reserve, the ECB, and policy easing in China.
Domestically, the BoC said that the economy is returning to growth around potential following the soft patch in late 2018 and early 2019. The Bank now projects 2019 Q2 GDP growth of 2.3%, up from April's 1.3% forecast.
Overall, the forecast for GDP growth in 2019 was increased slightly to 1.3%, from the prior 1.2%. The upgrade was due to an increase in the positive contributions from consumption and exports, and a smaller negative contribution from business investment.
For 2020, the Bank lowered its GDP growth forecast to 1.9% from the earlier 2.1%. The downgrade was due to smaller positive contributions from exports and business investment, as a result of the dampening impact of ongoing trade conflicts.
Inflation is projected dip below the 2% inflation target this year owing to temporary factors, and to remain around target thereafter.
The Canadian dollar sold off following the Bank of Canada's press statement. That said, it merely dipped to levels it was trading at prior to prepared testimony from Federal Reserve Board Chairman Jerome Powell. Nonetheless, the reaction of the Canadian dollar suggests that the market considered the Bank's statement to be more dovish than anticipated.
In our view, the Bank of Canada gave little hint about the direction of possible future changes in the policy rate, but still expressed concern about the potential effects of global trade wars. We do not think that the policy statement was dovish, per se. Global economic developments might, at some point, require a rate cut, but that is far from clear at the present time.
The easing domestic headwinds, and the gathering global storm clouds were reflected in the Bank of Canada's updated GDP growth forecasts. Hence, there was a small upgrade to the 2019 outlook, with consumption, exports and business investment doing better than had been anticipated in the April Monetary Policy Report. The positive contribution from consumption was lifted to 1.2 ppt from the prior 0.9 ppt. Exports and business investment are expected to make a positive 0.4 ppt contribution to GDP growth in 2019, up from the prior 0.1 ppt.
However, the global trade tensions were reflected in downgrades to the contributions from exports and business investment in 2020. As a result, exports and business investment are expected to make a combined 0.9 ppt contribution to 2020 GDP growth. This would be down from the prior 1.3 ppt. Global trade tensions have resulted in somewhat less optimism on exports and business investment, though the Bank continues to see the performance of exports and business investment improving in 2020 compared to 2019.
The Bank of Canada did discuss the risks associated with global trade policies. Those risks are deemed "two-sided." The analysis looks at two scenarios: One is an extreme downside scenario, and the second is an upside scenario where trade-related uncertainties dissipate. The analysis highlights the severe downside risks to a worsening of the global trade backdrop, and the risks from trade policies are skewed to the downside.
Overall, we see the Bank of Canada as concerned about the potential for additional negative economic fallout from global trade tensions. However, we sense no hint of urgency to move the policy rate from the current 1.75%, unless these risks materialize more fully. Accordingly, we remain comfortable with our forecast the next move in the policy rate will be a rate cut, but not until 2020 H2.