BoC: Rates unchanged, cautious statement - Rabobank

Christian Lawrence, Senior Market Strategist at Rabobank, notes that the Bank of Canada left the policy rate unchanged at 1.00% as was widely expected and the CAD sold off on the announcement given a very cautious accompanying statement.

Key Quotes

“The CAD OIS implied probability of a March rate hike fell around 15ppt to 60%.  The BoC’s stance was in line with our more-dovish-than-consensus view and we maintain our call that the next rate hike will occur at the April meeting.”

“There is a significant risk of an earlier move but we expect the Bank to wait until April when there will be an MPR and greater clarity as to NAFTA negotiations and Fed policy.”

“The Bank of Canada left the policy rate unchanged at 1.00% as was widely expected. The Bank struck a cautious tone and remains firmly in ‘wait and see’ mode although this meeting did little to answer the question of how precisely long the BoC is likely to wait. We have been erring on the more dovish side when it comes to our forecast for the Bank’s tightening cycle.”

“Yesterday’s statement provided support to our view as the BoC struck a cautious tone on Canada. Indeed, the front-end of the CAD OIS curve moved lower in the aftermath of the decision with the 45% implied probability of a January move dropping to 33% while the 75% implied probability of a March fell to 60%. As we outlined in our Bank of Canada Preview, our base case is that the BoC waits until Q2 before raising rates again. By that time we will have more data revealing how households have coped with the 50bp of tightening seen in 2017 H2 and we should also have more clarity as to the outcome of NAFTA negotiations following the 6th round (late January) and the final 7th round (March). Waiting for April has the added benefit of allowing the Bank to see if the Fed has raised rates at its March meeting. Our Fed watcher, Philip Marey, expects the Fed to wait until June to hike again following a likely December rate hike. While this is our base case, we are cognisant that the balance of risks are skewed towards an earlier rather than later move.”

“In terms of the statement, the Bank viewed the global economy as progressing in a similar manner to that outlined in the BoC’s October Monetary Policy Report (MPR). In terms of Canada, the Bank had an optimistic but cautious tone. It was noted that employment growth has been strong, wage growth is picking up gradually and consumer spending has been robust. On that latter point we would offer some caution, however, as this picture could change rapidly should recent hikes start to pinch households.”

“The Bank is more than aware of this, noting that: “While higher interest rates will likely be required over time, Governing Council will continue to be cautious, guided by incoming data in assessing the economy’s sensitivity to interest rates”. The statement did note temporary factors driving inflation but the pick-up in core inflation is a sign of “continued absorption of economic slack”. Meanwhile, on growth the Bank highlighted that “Revisions to past quarterly national accounts have resulted in a higher level of GDP. However, this is unlikely to have significant implications for the output gap because the revisions also imply a higher level of potential output.”

“In terms of the market reaction, in line with falling short end rates, USD/CAD lurched a big figure higher from 1.2675 to north of 1.2775. We still see 1.26-1.28 as the likely trading range into yearend although we see a move towards 1.29 in January if our call for another ‘on-hold’ decision on the 17th comes to fruition. After the first BoC meeting of the year, NAFTA negotiations will come back into focus and although our base case is for talks to continue into the 7th round scheduled for March, any sign that talks are breaking down or if Trump threatens triggering Article 2205 then there is the potential for a move back to a 1.3 handle in USD/CAD.”