Loonie’s strength complicates Bank of Canada interest rate decision

Posted by on September 6, 2017

After the Canadian market’s sizzling performance in the second quarter, all eyes will be on the Bank of Canada this week for an expected interest-rate hike.

But there is at least one obstacle standing in the bank’s way: a resurgent loonie.

Since early May, the Canadian dollar has surged more than 10 percent against the U.S. greenback, propelled by strong economic data which culminated with growth of 4.5 percent in the second quarter. A rate hike on Wednesday — coming shortly after July’s quarter-point increase — risks sparking another rally in the dollar, which ended last week at roughly 80.7 pennies (U.S.).

The loonie’s strength is complicating what could otherwise be a simple decision for the lender, economists say.

“Nudging interest rates a quarter-point greater is obviously warranted after a scorching first half.

“We do not desire rates this low to create adequate growth and may ameliorate future financial-system risks by easing family credit demand,” CIBC’s chief economist, Avery Shenfeld, said in a note.

“However a further climb from the Canada dollar is significantly less welcome.”

A higher dollar could put a dent in exports. It could also promote disinflation in a time when the central bank “requires somewhat more inflation,” he said.

The way the lender plans to walk this tightrope will become clearer as it releases its coverage interest-rate statement at 10 a.m. on Wednesday.

The benchmark overnight rate now sits at 0.75 percent, and if the bank hikes now or in October, it will probably try to maintain the loonie’s rise in check by handling the market’s expectations.

If it decides to proceed this week, it might, as an instance, conclude its statement by claiming that “monetary-policy settings are now appropriate,” Mr. Shenfeld said. That would send a signal that the bank is likely done edging for today. The lender could underscore its message by “pointing to still-tame core inflation and a firm Canadian dollar as a drag on growth,” he said.

Otherwise, the lender could leave its interest rate unchanged on Wednesday and postpone the increase until its next meeting on Oct. 25. Holding off could send a signal that the bank plans to increase rates only slowly. However, the announcement will most likely paint a bullish picture of expansion, which will make an October increase look like a slam dunk.

Raising the overnight rate to 1 percent this week — and signalling that the lender will then move to the sidelines — is probably the best option, Mr. Shenfeld said. “Why not get the message out early a 1-per-cent speed is here to stay for some time?”

Bank of Nova Scotia also expects the central bank to proceed sooner rather than later.

“Growth has been much exceeding the Bank of Canada’s predictions for a protracted period,” said Derek Holt, the bank’s head of capital-markets economics, noting that the annualized growth rate over the previous four quarters averaged a very powerful 3.75 percent.

If this pace of expansion “were to continue unabated, then imbalances and inflationary consequences would place Canada in the outer border of the international experiment over how quickly the economy can grow and for how long without stoking pressure points which would be hard to undo,” Mr. Holt said.

To keep a lid on inflation, the central bank will probably increase its coverage rate a few more times in 2018, bringing the total increase to approximately one percentage point, ” he said. However, Mr. Holt said a hike this week isn’t guaranteed.

Some economists doubt that the bank will be in a hurry to pull the trigger.

Benjamin Reitzes, Canadian rates and macro strategist with Bank of Montreal, points out the lender is scheduled to issue just a statement this week, whereas the October meeting will include a more sophisticated monetary-policy report which will give the bank a chance to flesh out its own message.

“That is part of the reason why another hike is not likely at this juncture,” he explained in a note. Bank of Canada Governor Stephen Poloz and senior deputy Governor Carolyn Wilkins “have emphasized that the Bank would like to prevent slamming on the brakes; trekking in consecutive meetings could send a message along those lines. And, only with a statement makes it tough to effectively communicate differently,” Mr. Reitzes said.

There are other reasons to expect the lender to remain put on Wednesday, ” he said. It’s been silent since July, “providing zero messaging in any respect,” he said. “That is a stark contrast in the lead-up into the July increase when a range of BoC officials were paraded out to deliver the message that a increase was coming{}”

The issue with increasing rates this week is that it “could sharply strengthen the Canadian dollar and tighten financial conditions over the lender would enjoy,” he said.

This week will also bring another batch of economic data for the lender to chew on, the highlight being Friday’s employment report for August.

With the economy firing on all cylinders, the report is expected to reveal another month of solid job growth. Economists, on average, expect a profit of roughly 15,000 jobs, after July’s increase of 11,000. The unemployment rate is forecast to hold steady at 6.3 percent.

“A sexy job market has helped power consumer spending, which in turn has been the big surprise in GDP growth this year,” stated Andrew Grantham, senior economist with CIBC.

Courtesy: The Globe And Mail

Posted in: Business Insight


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