Bank of Canada forecasts raise the bar for policy easing

April 30, 2019

By Fergal Smith

TORONTO (Reuters) – Canada’s central bank is buying time for the economy to exit a soft patch without the aid of lower interest rates, economists say, by forecasting growth so weak it would take a surprise blow to activity for the economy to undershoot its estimates.

Money markets see about a 50 percent chance of an interest rate cut this year by the Bank of Canada. But the central bank’s tepid growth projection has raised the bar for policy easing, according to market players.

“The aim is to be on the sidelines but also to avoid the pressure of having to cut rates,” said Adam Button, chief currency analyst at ForexLive. “A low forecast gives them maximum flexibility through year end.”

The Bank of Canada held interest rates steady at 1.75 percent last week as it slashed its gross domestic product growth forecast for the year to 1.2 percent from 1.7 percent in January.

Canada’s economy unexpectedly shrank in February, a report showed on Tuesday. But forecasters said they still expected the economy to expand faster than the central bank’s projection of 0.3 percent annualized in the first quarter, according to bank research notes.

“Had the outlook warranted a rate cut, it would have come at that meeting,” said Royce Mendes, a senior economist at CIBC Capital Markets. “Unless there is a new negative shock to the economy, they won’t be cutting rates, even if growth is undershooting potential by a moderate margin.”

That means that the central bank will be on the sidelines during the campaign ahead of October’s national election. Liberal Prime Minister Justin Trudeau is trailing his main rival, Conservative leader Andrew Scheer, polls show.

The Bank of Canada’s estimate of potential growth, the highest rate that the economy can sustain, is 1.8 percent. The central bank has said that it is monitoring developments in household spending, oil markets and global trade.

Bank of Canada Governor Stephen Poloz has gone from being one of the most optimistic forecasters “on the street” to one of the gloomiest, said Stéfane Marion, chief economist at National Bank Financial in a note, adding that the lower growth forecasts were an “overkill.”

Still, Poloz has said that the central bank could start raising rates again “sometime down the road” should upcoming economic data back up the central bank’s assessment that a current slowdown is only temporary.

The Bank of Canada, which has tightened by 125 basis points since July 2017, expects growth to pick up in the second half of the year and for the economy to grow 2.1 percent in 2020.

Data last Friday showing much stronger-than-expected growth in the United States, where Canada sends about 75 percent of its exports, and recent stabilization in domestic credit growth could support the central bank’s expectation for growth to recover.

“It’s all about managing those rate cut expectations,” ForexLive’s Button said.

(Reporting by Fergal Smith, editing by Steve Scherer and James Dalgleish)

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