BoC to leave rates on hold at 1.00% - Rabobank

Christian Lawrence, Senior Market Strategist at Rabobank, expects the Bank of Canada to leave rates on hold at 1.00% today and the OIS curve currently implies around a 20% chance of a 25bp hike to 1.25%.

Key Quotes

“We expect the Bank to maintain a cautious tightening bias.”

“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.”

“Of the 26 analysts surveyed by Bloomberg, only four expect a 25bp hike. Looking further out, the front end of the curve shows just a 25% probability that the policy rate remains unchanged heading into Q2 and only an 8% chance of a 1% policy rate heading into the second half of the year. Although we do expect the Bank will have raised rates by 2018 H2, we see a far greater than 25% chance of a 1% policy rate heading into Q2. Indeed, our base case is for the next 25bp hike to be announced at the April 18th meeting. The risk to that view is that we see wage growth continue to pick-up and core inflation follows suit opening the door for an earlier 25bp move.”

“The October MPR that accompanied the last decision revealed a downgrade in inflation projections this year while GDP growth was seen notably stronger than expected in the previous MPR released back in July. This, a product of a much stronger first half of the year. Data since that meeting have generally surprised to the upside as well with Q3 GDP growth printing at an annualised 1.7% (down from 4.5% in Q2), while survey data got off to a strong start in Q4 with the Ivey PMI rising to a 21mth high of 63.8. Labor data remain robust; the unemployment rate stands at 5.9%, the lowest print since the all-time low of 5.8% back in October 2007. Jobs quality has also improved alongside quantity with 370.5k full-time jobs added so far this year compared to just 70.5k in 2016. In the part time jobs space, there has been a decline of 26.7k this year compared to an extra 155.6k part time jobs seen last year. The improvement in quality as well as quantity has led to an increase in wage growth, albeit from the record low pace seen in April.”

“All this said, we expect the Bank to maintain a cautious tone following the 50bp of tightening already seen in the second half of this year. Indeed, a big question mark remains over the impact of recent rate hikes on households. Given excessively high household leverage, it is unsurprising that the BoC has suggested that households might be more sensitive to interest rate increases than they have been historically. The BoC’s recent financial stability report noted that household debt remains a key weakness and although the financial system is “resilient” there is increasing risk when it comes to low-ratio mortgages that are increasingly going to high debt households.”

“In summary, although the underlying picture is improving, we expect the Bank to wait until Q2 before raising rates again as this will allow the Bank more time to assess the impact of recent rate hikes.” 

“It is also worth noting that round 6 of the NAFTA negotiations is scheduled for late January with the 7th and final round of negotiations will be held in March. Although we do not expect NAFTA negotiations to be a primary driver of BoC policy, the added benefit of waiting until we have a better idea as to the likely outcome is an added bonus to waiting until Q2. Indeed, talks have soured somewhat and although our base case remains a renegotiation, we cannot rule out termination. We can see this NAFTA risk in price action given the divergence between USD/CAD spot and our Rabo CAD Market Model which currently implies around 0.04 of “NAFTA risk” imbedded in the current 1.266 spot price.”