BoC: Turning optimistic – BMO CM

Benjamin Reitzes, Canadian Rates & Macro Strategist at BMO Capital Markets, explains that the Bank of Canada appears to be turning more optimistic on the Canadian economy as last week’s statement spent many more words highlighting the positives, rather than emphasizing the negatives.

Key Quotes

“We saw two changes to the statement as particularly important. First, the Bank dropped the word “material” when referring to “excess capacity”. That’s clearly less dovish and shows they believe the output gap is shrinking. (Which should be clear given Q1 GDP growth… but this solidifies that point). Second, while the BoC noted that core inflation measures have slowed, they didn’t seem overly fussed and suggested that food disinflation—which is not relative to capacity pressures—is having a meaningful impact.”

“Despite the more positive tone, there were still some notes of caution. Indeed, “the uncertainties outlined in the April MPR continue to cloud the global and Canadian outlooks.” Unfortunately, many of those uncertainties aren’t likely to clear up in the near term. The Canada-U.S. trade relationship could remain in flux until year-end. NAFTA renegotiation doesn’t start until August at the earliest, and those talks will probably take a few months at the very least. U.S. fiscal policy is a big question mark. Europe continues to face political uncertainty. Oil prices are struggling to hold on to $50. And, the full impact of the new housing measures won’t be known for months. There remain plenty of reasons to be cautious, but that’s exactly why the BoC is still a long way from raising rates.”

“Perhaps the biggest thing to watch through the summer months is whether the slowdown in Toronto/Ontario housing has a knock-on effect on other sectors, notably consumption. Note that Ontario accounts for about a 40% share of the national economy (similar for housing), so any softness will clearly impact headline growth. This could be a meaningful downside risk to the outlook and one of the few made-in-Canada risks. The eruption of a broad construction strike in Quebec is another factor—a prior such strike in June 2013 saw a 0.4% drop in GDP that month on a 2.1% plunge in construction.”

“Key Takeaway: The BoC took a baby step toward an eventual rate hike, though we’re still a long way from a move. Our other key takeaway is that, barring some catastrophe (the usual caveat), a rate cut is all but off the table.”