Bank of Canada not ready to move

November 27, 2015 01:07 PM

After shocking markets with an interest rate cut at the start of the year, the Bank of Canada is expected to end 2015 on a more sedate note, holding rates steady through next year and waiting for better U.S. growth to provide a boost, a Reuters poll found.

The central bank is almost certain to keep rates unchanged at 0.50% on Dec 2 at the conclusion of its policy meeting, the poll of over 40 economists taken Nov 23-26 showed.

That steady policy stance stands in contrast to the U.S. Federal Reserve, which is now widely expected to raise its key interest rate for the first time in nearly a decade just weeks later.

While the U.S. economy is performing well, Canada's economy slipped into a mild recession in the first half of the year following a crash in the price of oil, a key export. The United States is by far Canada's biggest trading partner.

But Canada's growth is expected to roughly meet the Bank's forecast of 1.5 percent in the fourth quarter, and is likely to pick up pace from there, so long as the United States keeps performing well.

"I would characterize the U.S. recovery as reducing the likelihood that the Bank of Canada will need to cut rates again," said Andrew Kelvin, senior rates strategist at TD Securities, who expects no change in rates until June 2017. 

The central bank cut rates twice this year to offset the negative effects of the oil price plunge. Oil prices have fallen by more than half since June 2014 and the Canadian dollar is on track to mark its worst year since the 2008 financial crisis.

BoC Governor Stephen Poloz has said the weaker currency should lead to stronger U.S. demand for Canadian exports and boost the Canadian economy.

"There is just no pressing need for the Bank of Canada to move rates higher, particularly with the exports recovery still at very early stages and business investment lagging. And most importantly, the inflation pressure in the bank's view is simply not there," said TD Securities' Kelvin.

A minority of economists said further monetary policy stimulus might still be needed sometime next year.

"Additional downward pressures on oil prices could trigger more cuts in the energy sector in Alberta, putting back Canada's economy in recession in early 2016," said Dominique Lapointe, economist at Laurentian Bank Securities. 

Nonetheless, the likelihood that the next move from the Bank will be a cut has decreased to 20 percent from the almost one-in-three possibility forecasters predicted in October's poll.



Some also pointed to the risks that a housing market that is overvalued, certainly by international standards, could pose as Canadians take on more and more debt to buy property. 

Years of loose monetary policy sent the household debt-to-income ratio to a record high just under 165 percent by the end of June, raising fears a housing market correction is around the corner.

"A disorderly pull-back in residential investment might necessitate additional monetary stimulus," said Lapointe.

Poloz has acknowledged high household borrowing as one of the biggest vulnerabilities for the Canadian financial system, though the Bank expects the most likely scenario is that home prices will stabilize.

While 17 economists in the poll did not think the bank was underestimating the risk of a correction in the housing market, 10 thought it was. 

"Household debt levels are not showing any signs of moderating, indicating that, going forward, the risk of a correction in the household sector is getting bigger," said Jean-Paul Lam, associate professor of economics at the University of Waterloo.

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