There is widespread anticipation that the Bank of Canada’s statement this week will carry a more dovish tone than the previous statement in December. Some believe that it could even carry an explicit reference to a future rate cut. We do not agree with the consensus. First, as we discuss below, not enough has changed since December to necessarily justify action. Second, both quantitative and anecdotal evidence suggests that the market is already heavily positioned for a more dovish tone and therefore the risks are to the upside for the Loonie coming out of this announcement. That is, unless we get a fairly significant and explicit change in tone, Canadian Dollar shorts are likely to be disappointed. The key parts of the Bank’s statement from December are shown below in Italics, followed by our commentary. The global economy is expanding at a modest rate, as the Bank expected. Although growth in several emerging markets has continued to ease, growth in the United States during the third quarter of 2013 was stronger than forecast. Even if some of this pickup was due to temporary factors, the data are consistent with the Bank’s view of gathering momentum in the U.S. economy. This paragraph is unlikely to change significantly. In fact, we may see a reference to the surprisingly strong US economic strength in the last month of 2013 which would argue against a more dovish tone. In Canada, underlying growth is broadly in line with the Bank’s projections in its October and July Monetary Policy Reports. Real GDP growth in the third quarter, at 2.7 per cent, was stronger than the Bank was projecting, but its composition does not yet indicate a rebalancing towards exports and investment. GDP growth continues to be in line with both market expectations and the bank’s estimates. In fact, for the last publicly available month, we had a small upside surprise to economic growth. The part about the composition of growth is unlikely to have changed. The housing sector has been stronger than expected but is consistent with updated demographic data and a pulling forward of home purchases in light of favourable financing conditions. The Bank continues to expect a soft landing in the housing market. Again, not much has changed here. The housing picture is somewhat murky but continues to largely defy gravity (or at least the bears calling for a hard landing). Non-commodity exports continue to disappoint and the price of oil produced in Canada has eased further. WCS prices are up since December and the WCS spread to WTI is tighter. Non-commodity exports probably continue to disappoint the insatiable appetite of our Central Bank but commodity prices generally are up since the December release. Business investment spending is up from previous low levels, but is still recovering more slowly than anticipated. On balance, the Bank sees no reason to adjust its expectation of a gradual return to full production capacity around the end of 2015. There is not much reliable public data to decipher on this one but it’s hard to imagine business investment is materially difference since December. Also, no reason to imagine the bank would adjust its estimates of full production capacity by the end of 2015. Meanwhile, inflation has moved further below the Bank’s 2 per cent target. Core inflation is being held down by significant excess supply and by the effects of heightened competition in the retail sector, which look to be more persistent than anticipated. In addition, total CPI inflation has been pushed down by lower gasoline prices. This is the main item on which those who expect a more dovish tone hang their hat. It is true that we had another month of lower than target inflation since the December release. But the Bank was already expecting this fact in its previous release. Indeed, inflation moved up very slightly in the last month which means that we are no longer technically moving “further below” the Bank’s target rate. The risks associated with elevated household imbalances have not materially changed, while the downside risks to inflation appear to be greater. Overall, the balance of risks remains within the zone articulated in October. Weighing these considerations, the Bank judges that the substantial monetary policy stimulus currently in place remains appropriate and therefore has decided to maintain the target for the overnight rate at 1 per cent. We believe the bank will likely continue to be more concerned both about low inflation than elevated household imbalances and that the “balance of risks” have not materially changed in favor of low inflation.
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