Why the Bank of Canada Punted With Its Latest Policy Statement

The Bank of Canada (BoC) left its policy rate unchanged last week, as was universally expected. The Bank also offered us some insight into our economy’s progress, or lack thereof.

Here are the highlights from the BoC’s latest statement, with my take on the meaning behind their messages:

• “The global economy is evolving largely as the Bank projected in its April Monetary Policy Report (MPR)” but the Bank noted that “ongoing geopolitical factors [are] contributing to fragile market sentiment”. That “fragile market sentiment” concerns the Bank because our GDP tends to move in the same direction as overall global GDP over time, so heightened geopolitical uncertainty pushes the BoC into a cautious, read-and-react position.
• The Bank offered a fairly positive assessment of where the U.S. economy is headed, discounting its weak first quarter and predicting it will experience “a return to solid growth in 2016”. There is much debate about what the U.S. economic data are telling us at the moment, but it is no surprise to hear that the BoC’s U.S. economic projections have an optimistic bent. It is worth remembering, however, that the Bank has consistently overshot with its U.S. economic projections.
• The BoC noted that our economy’s “structural adjustment to the oil price shock continues, but it is proving to be uneven” and while the Bank acknowledged that oil prices are higher, it attributes the recent price rise to “short-term supply disruptions”. The Bank is of course referring to the fires in Fort McMurray, which it estimates will “cut about 1 ¼ percentage points off of real GDP growth in the second quarter”. The BoC’s most recent forecast for our economy called for second quarter GDP growth of 1%, so unless something unforeseen happens, it appears that the Bank is now calling for our economy to contract slightly in Q2.
• The BoC cited concern that “business investment and intentions remain disappointing”. The Bank is hopeful that our economy will start to rebound in the third quarter, “as oil production resumes and reconstruction [in Fort McMurray] begins”, but hope is the operative word here because the BoC has been hoping that business investment will meaningfully increase since 2008.
• The Bank notes that while the Loonie “has been fluctuating in response to shifting expectations of U.S. monetary policy and higher oil prices, it is now close to the level assumed in April.” The recent drop in the Loonie has reduced the odds that the BoC would have to lower its overnight rate to stem its rise.
• “Inflation is roughly in line with the Bank’s expectations”. The Bank noted that overall inflation, as measured by the Consumer Price Index (CPI), “remains slightly below the 2 per cent target”, while core inflation remains “close to 2 per cent, reflecting the offsetting influences of past exchange rate depreciation and excess capacity.“ In different times the BoC might be more concerned about the fact that our overall CPI has risen in each of the past five months, and that our core inflation rate, which strips out more volatile CPI inputs like food and energy, came in above 2% for the second consecutive month. But in our current economic environment, the BoC’s primary focus is on growth, not inflation. As such, inflation would have to rise much higher before it would likely alter the Bank’s near-term policy plans.

I think that the BoC effectively decided to punt the ball to the U.S. Fed with its latest statement. There was nothing in last week’s announcement to tip either bond yields, or more importantly, the Loonie off of their current trajectories. Our economy remains in read-and-react mode where the combination of global geopolitical uncertainty and the U.S. Fed’s next policy-rate decision in June will determine where both are headed over the near term. The Bank has basically decided to wait and see how the Fed’s June meeting plays out before using its words and, if necessary, its actions, to counteract any unwanted volatility.

Five-year Government of Canada bond yields rose by two basis points last week, closing at 0.79% on Friday. Five-year fixed-rate mortgages are available in the 2.39% to 2.59% range, depending on the terms and conditions that are important to you, and five-year fixed-rate pre-approvals are offered at around 2.69%.

Five-year variable-rate mortgages are available in the prime minus 0.30% to prime minus 0.40% range, which translates into rates of 2.30% to 2.40% using today’s prime rate of 2.70%.

The Bottom Line: The BoC is now projecting that our economy will contract slightly in the second quarter of this year, largely as a result of the economic disruption caused by the fires in Fort McMurray. Despite this, the Bank’s overall position comes across as cautiously optimistic while it waits to see how global geopolitical uncertainties play out, and most directly, to see what effects the U.S. Fed’s June policy-rate decision will have on the Loonie and on our overall economic momentum.