In line with market expectations, the Bank of Canada left its target rate unchanged at 1.25 percent after today's Governing Council meeting. The post-meeting press release highlights three areas of uncertainty in the near-term outlook: GDP growth, US trade policy and the housing market. Let's look at these in turn.
First, growth. The press release notes that Canadian GDP grew by 3 percent in 2017, and mentions in passing that the economy is "operating near capacity". However, the pace of growth slowed markedly in the second half of last year, averaging just slightly above 1.5 percent in Q3 and Q4. Data for Q1/2018 are still patchy, but the sharp decline in part-time employment in January will certainly have caught the Bank's attention.
Was this (a) just another example of the volatility of the sub-components in the Labour Force Survey, and thus likely to reverse or at least even out over time; (b) a one-off adjustment to the leap in Ontario's minimum wage at the start of the year; or (c) a harbinger of a much softer trend in the jobs market, keeping in mind that employment is usually seen as a lagging indicator of economic activity? Data for February will be released this coming Friday, and should provide greater certainty over the near-term direction of the jobs market.
Second, trade policy. Uncertainty over the fate of NAFTA has been weighing on sentiment (and on the exchange rate) for some time, and now President Trump has threatened to impose tariffs on US imports of steel and aluminum, both key products for Canada. Canadian Foreign Minister Chrystia Freeland initially made the ludicrous suggestion that NAFTA and steel tariffs were separate issues, but it is crystal clear that Trump is using the tariff threat to put pressure on the NAFTA negotiations.
Canada is directly in the firing line as far as steel and aluminum are concerned -- the ostensible target, China, is not a big player in either, at least as far as trade with the US is concerned -- but a wide range of countries are threatening retaliation if the US goes ahead. Comparisons with the disastrous effects of the Smoot-Hawley Tariff Act in the 1930s may be overwrought, but any significant slowing in global trade would have a noticeable impact on Canada's own growth, and hence on the Bank's rate decisions.
Lastly, housing. The Toronto real estate market took a dive in February, both in terms of prices and completed sales. It's striking to see that the Toronto Real Estate Board, in a desperate attempt to put a brave face on things, is resorting to comparing prices to those of two years ago, playing down the usual year-on-year comparisons. The Board always claimed to expect that the market would be slow in the winter months as buyers and sellers came to grips with new mortgage rules, with a pickup later in the year as fundamentals reasserted themselves. If those fundamentals now include slower economic growth and worsening employment prospects, that rebound may not show up.
Where does all of this leave the Bank? The press release states that the outlook will still "warrant higher interest rates over time", but makes it clear that everything depends on the data. Until recently, most analysts had expected three further rate hikes this year, more or less in line with the expected pace of Fed tightening. At least one credible analyst (at BlackRock) sees no more than one more move this year, and conceivably no change at all. One thing seems certain: the prospect of a trade war with Canada's biggest customer, coupled with the increasing likelihood that the Bank of Canada will lag the Fed in terms of tightening, means that the recent underperformance of the Canadian dollar will continue for some time to come.
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