Week in review: BoC cut its overnight rate at its July meeting to offer more stimulus

Week in review

Canada – The consumer price index rose 0.2% in June, allowing the year-on-year inflation rate to rise one tick to 1.0% (from 0.9%). In seasonally adjusted terms, CPI rose 0.4%, with gains in 7 of the eight broad categories: transportation (+1.3% largely due to gasoline), recreation/education (+0.4%), clothing/footwear (+0.1%), shelter (+0.2%), food (+0.1%), household ops (+0.1%), and alcohol/beverage (+0.1%). Prices were flat for health/personal care. The core CPI, which excludes eight of the most volatile items, was flat (but was up 0.3% in seasonally adjusted terms), causing a one-tick increase in the year-on-year core inflation rate to 2.3% (from 2.2%).

Manufacturing shipments rose just 0.1% in May. Six of the 21 industries posted higher sales (those six industries account for roughly half of the manufacturing sector), including the volatile aerospace category (+22%), and petroleum/coal products. In real terms, factory sales fell 0.5%, the fourth decline in the last five months. Assuming no change in June, Q2 real shipments contracted for a third straight quarter, something not seen since the 2008-09 recession. That supports our view the economy didn’t get much of a rebound last quarter after Q1’s surprise GDP drop.

International securities transactions data showed foreign investors decreasing their holdings of Canadian securities by C$5.5 bn in May, with net selling of equities (-C$5.7 bn) and money market instruments (-C$0.3 bn) dwarfing increases for bonds (+C$0.5 bn). The bond net inflows were entirely in government enterprises (+C$5.4 bn) which offset net selling of private corps, federal government bonds (-C$2 bn), provies (- C$2.5 bn) and munis (-C$60 million). The net selling of Canadian securities in May has to be looked at in context since that came after a massive surge in prior months. In fact, net inflows in the first five months amounted to C$48 bn, the best start of the year since 2010.

The Teranet–National Bank House Price Index rose 1.4% in June, a sixth increase in a row thanks to gains in seven of the 11 metropolitan regions covered. On a year-on-year basis, home prices were up 5.1% nationally with above average increases in Vancouver (8.5%), Toronto (7.8%), Victoria (5.7%), Hamilton (5.5%), and below average increases in Edmonton (3.6%), Quebec City (2.8%), Winnipeg and Halifax (1.2%), Ottawa-Gatineau (0.3%) and Calgary (0.2%). The only city in deflation mode on a year-on-year basis was Montreal (- 0.4%).

The Bank of Canada cut its overnight rate to 0.50% at its July meeting. The central bank supported its decision to offer more stimulus by presenting a much downgraded outlook for Canada’s economy ― the central bank lowered its growth forecast for 2015 to just 1.1% (from 1.9%), and even lowered next year’s forecast to 2.3% (from 2.5%). There was, however, an upgrade to 2017 to 2.6% (from 2.0%). The downgrade this year was largely due to investment whose contribution was lowered from -0.7% to -0.9%. Exports were also downgraded a bit. Gross domestic income is now expected to contract 0.7% this year (versus +0.2% in the prior estimate) largely due to a much downgraded outlook for commodity prices. The central bank estimates the output gap widened further to reach between 1.25% and 2.25% at the end of Q2, and it now expects the gap to close only in the first half of 2017. The BoC’s inflation forecasts were mostly unchanged, with headline inflation not expected to return to 2% before early 2016.

In the press conference, Governor Poloz explained the BoC’s changed stance. He said there were three factors behind the growth downgrade: Lower oil price outlook and weak investment from energy producers, China’s economy undergoing a structural transition resulting in headwinds for Canada, faltering non-resource exports which are “puzzling”. The Governor acknowledged that the decision to cut rates may worsen already elevated financial stability vulnerabilities but thought that the decision was nonetheless necessary to lower risks to financial stability, e.g. lower the probability of a downturn in the labour market. But not all is bleak according to the Governor. He said that outside of the energy sector, the economy is still showing resilience, i.e. 82% of the economy is still growing at a decent pace of about 2%. Since weakness wasn’t broad based, the Governor didn’t want to be dragged into a debate about whether or not Canada is in a recession. The Governor expects Canada to be less synchronized with the US (i.e. diverging growth) due to the terms of trade shock, and suggested monetary policy will also diverge. The Governor remains confident the economy will gain steam but if there were further disappointments to growth, the BoC has further tools at its disposal including forward guidance and QE.