Canada: Don't expect much change from the central bank's policy

Week in review

Canada – The consumer price index fell 0.1% in April, allowing the year-on-year inflation rate to drop to 0.8%, the lowest since November 2013. In seasonally adjusted terms, CPI also fell 0.1%, as declines for transportation, clothing/footwear, shelter and recreation/education more than offset gains in the other four broad categories. The core CPI, which excludes eight of the most volatile items, was up 0.1%, but that couldn’t prevent a one-tick drop in the year-on-year core inflation rate to 2.3% (from 2.4%). In seasonally-adjusted terms, core CPI was flat. Assuming seasonal patterns hold in May and June, CPI is on track to grow in Q2 by 0.7% annualized for the headline and 2.2% annualized for the core, close to the Bank of Canada’s April’s Monetary Policy Report estimates of 0.8% for the headline and 2.1% for the core. So, don’t expect much change from the central bank’s policy stance for now.

Retail sales rose 0.7% in March, after a downwardly revised 1.5% increase in the prior month. Sales rose in 7 of the 11 subsectors, including a 1.5% increase for autos/parts dealers. Excluding autos, sales rose 0.5%. There were increases observed for sellers of furniture, building materials, food/beverage, health/personal care products, clothing, and miscellaneous items which dwarfed decreases for sellers of electronics, gasoline, sporting goods, and general merchandise. In real terms, retail sales rose just 0.1%. Overall, the Canadian retail results were much better than expected even considering the downward revision to the prior month. The retail volume increase adds to solid performances reported earlier from factories and the wholesale sector, suggesting Canada’s GDP growth accelerated in March, i.e. a good handoff to Q2. The Q1 picture, however, is less rosy with real retail sales contracting at an annualized pace of 1.6%, the worst since 2012.

Wholesale sales rose 0.8% in March, close to consensus expectations. There were increases in five of the 7 subsectors, including +0.7% for autos/parts, +2.8% for building materials, +1.2% for food/beverage, and +1.5% for personal/household goods. Inventories were up 1%. In real terms, wholesale sales rose 1% in March, although not preventing a 7.4% annualized contraction in Q1 because of the poor start to the year.

Bank of Canada Governor Stephen Poloz didn’t signal any change in the central bank’s policy stance in a speech in Charlottetown this week. He again said that the impact of the oil shock is proving to be faster than expected but not larger. But the impact on the labour market isn’t as front-loaded based on his comments that “we probably still haven’t seen the full impact of the oil price shock reflected in the employment data”. Output was about flat in the first quarter, but the BoC expects growth will rebound, particularly in the second half of the year and put Canada back on track to reach full capacity around the end of 2016. While core inflation remains above the central bank’s 2% target, Governor Poloz said that was due to temporary factors and pegged the “underlying trend” between 1.6% and 1.8%.

Following the speech, the Governor gave a press conference in which he admitted the central bank couldn’t be sure about the overall impact of the oil shock on the economy. With regards to the US, the Governor said it’s too early to say how strong the economy will be in Q2. He still sounded confident that the Canadian economy will benefit from the US moving from a consumer led recovery to investment led growth.

United States – The consumer price index rose just 0.1% in April, causing the annual inflation rate to drop to -0.2% (from -0.1% in the prior month). The 1.3% decrease in energy prices and flat food prices weighed on the CPI. Excluding food and energy, prices rose 0.3% thanks to gains for medical care, recreation, and apparel among others, which allowed the yearon- year core inflation rate to stay unchanged at 1.8%. All told, prices generally remain mild. We expect inflation to remain soft as the strong US dollar continues to cap import prices and offset the natural lift to prices brought by a strengthening economy. Based only on inflation considerations, the Fed is under no pressure to hike interest rates.

Housing starts soared 20.2% to 1135K in April, from an upwardly revised 944K in the prior month. There were big increases for both single-family homes (+16.7%) and multis (+27.2%). Building permit applications also jumped 10.1% to 1143K in April. The increase was largely due to multis (+20.5%) although permits for single family homes were also up 3.7%.

Existing home sales fell 3.3% to 5.04 million units in April after an upwardly revised print of 5.21 million units in the prior month. The declines were entirely due to single family units (- 3.7%), while sales of multis were flat. The months supply of homes at current sales rate jumped to 5.3, the highest since September last year. But the median resale price rose to $219,400 and is now 8.9% higher than year-ago levels (+10% for singles and +0.4% for multis). About 24% of April sales were made to cash buyers while the share of distressed sales in total sales was unchanged at 10%.

The leading indicator rose a consensus-topping 0.7% in April, the largest monthly increase since July last year. The biggest contributors to the increase were building permits and interest rate spreads.

The Philadelphia Fed index of manufacturing activity fell to 6.7 in May (from 7.5 in the prior month). The employment subindex fell a bit but remained in expansion territory. The shipments and new orders sub-index rose and are both in expansion mode.

Fed minutes highlighted discussions among FOMC participants about whether the weakness in Q1 reflected temporary factors or a more long-lasting loss of momentum. The general view was that Q1 was a temporary setback although a number of participants suggested that the impact of the dollar on net exports and the decline in oil prices on investments spending might be larger and longer-lasting than previously anticipated. A few participants thought downside risk to the economy had increased since March. There were discussions about financial stability, and some participants were concerned that term premiums may increase sharply once the FOMC begins policy normalization. They thought that the combination of high-frequency traders, decreased inventories of bonds held by dealers, and elevated assets of bond funds, was a recipe for greater bond market volatility than in the past. As for the timing of rate lift-off, many participants thought it was unlikely that the data available in June would provide sufficient confirmation that conditions for raising the fed funds rate had been satisfied. In other words, rate hikes are likely to be delayed to the second half of the year.

World – In Japan, GDP expanded for the second straight quarter in Q1 with a +2.4% annualized print, the biggest jump since 2013. Domestic demand, helped by a solid performance from consumers and to a lesser extent housing and investment, more than offset the drag from trade.