Bank of Canada to diverge from Fed’s easing path this year

The Bank of Canada (BoC) will diverge from the US Federal Reserve’s expected policy easing path and keep interest rates on hold at least through this year, according to economists in a Reuters poll who said however that the risk of a recession has risen.

The Fed, the European Central Bank and other major central banks are set to embark on an easing policy in coming months, or already have, to combat sluggish inflation and slowing economic growth exacerbated by global trade tensions.

But the BoC will take a different route and keep its key interest rate on hold at 1.75% through to the end of next year at least, according to the poll of nearly 40 economists taken on July 1-4, supported by recent upbeat domestic activity.

That bias, though, is expected to change next year as growth takes a hit.

Indeed, not only has the probability of a BoC easing for both this year and next risen, there are more economists now who predict at least one rate cut at some point before the end of next year compared to the previous poll in May.

Back then, forecasters were split in three directions about the BoC’s policy path. But now about 40% with a view to end-2020 expect the Bank to cut rates at least once, including two respondents predicting it to happen this quarter.

Only a handful said the central bank will hike rates next year.

“For the Bank of Canada, there is no rush to cut interest rates. At the same time, with the Fed moving relatively aggressively to cut interest rates, the BoC by next year will have to cut at least once in order to prevent the Canadian dollar from appreciating too strongly,” said Benjamin Tal, deputy chief economist at CIBC.

“So the question is how long can you divorce yourself from the Fed if you are the BoC, and I say not for too long.”

That lines up with the view of currency strategists in a separate poll who predict the Canadian dollar will stay firm against the dollar in a year as a recovering domestic economy forestalls BoC interest rate cuts.

“A deterioration in US-China trade tensions, a broader Chinese ban of Canadian products, a Canadian dollar soaring above 80 US cents coming from the Fed cutting aggressively would then force the BoC to join the easing bias camp,” said Sebastien Lavoie, chief economist at Laurentian Bank. The poll showed the Canadian economy is forecast to lose momentum considerably, slowing to a growth rate of 1.5% by the end of next year from the 2.2% expected for the previous quarter.

Over 80% of economists responding to an additional question said the risk to that already-modest growth outlook was skewed more to the downside. While US President Donald Trump provided some temporary relief at the G20 summit the chances of a recession in Canada have increased with no let-up yet in trade uncertainty. The median probability of a recession in the next 12 months rose to 25% compared to April’s 20%. The chances of a recession in the next two years rose to 35% from 27.5%. Trade concerns and sluggish global demand will likely squeeze recent gains in the price of oil - Canada’s key export, according to a separate Reuters poll.

That will keep inflation around the central bank’s target of around 2% in check. Inflation was expected to average 1.9% this year and 2% next, from 1.8% and 2% in April.

“Canada’s nascent mid-year rebound is expected to be short-lived as lingering domestic challenges, a slowing global and US economy and lower rates in the US may prompt the BoC to cut rates later this year,” said Tony Stillo, director of Canada economics at Oxford Economics. The Canadian dollar was little changed against its US counterpart on Thursday, holding near an earlier eight-month high which was notched after a number of recent data releases pointed to a pick up in the domestic economy.

The Canadian dollar was trading nearly unchanged at 1.3055 to the greenback, or 76.60 US cents. The currency touched its strongest level since Oct. 25, last year at 1.3038, while its weakest was 1.3079. The narrow range for the currency came as markets were closed in the United States for the Independence Day holiday.

“There is certainly decent momentum for the Canadian dollar given the string of strong and somewhat surprising data,” said Michael Goshko, a corporate risk manager at Western Union Business Solutions.

Data last Friday showed faster-than-expected growth in Canada’s economy in April, while a report on Wednesday showed a surprise swing in the May trade balance to surplus. Canada’s jobs report for June is due on Friday.

“Until the data begins to really soften in Canada, the BoC is going to be standing pat as far as the eye can see ... that’s certainly at odds with what is going on in the United States.”

Reuters