Divergent paths

It's rare to have a day on which both the US Federal Reserve and the Bank of Canada make rate announcements, but today has been such a day.  With the Fed cutting the funds target by a further 25 basis points and the Bank of Canada once again standing pat, the current divergence between the paths of the two central banks is becoming ever more pronounced.

The Fed's decision to cut rates again was fully priced in by the markets.  With the announcement earlier in the day that US GDP growth slowed to an annualized 1.9 percent in Q3, it is arguable that the Fed has fallen a little behind the curve in its easing cycle, a fact which means, alas, that Donald Trump's criticisms of Fed Chair Jerome Powell have at least some validity.

There had been some speculation that today's might be a "hawkish cut" with the Fed altering the wording of its press release to signify that it regards the easing cycle as being at an end. In the event, today's press release varied only slightly from September's, but the changes can be seen as very slightly hawkish.  While the Fed's policy path will remain data-dependent, previous references to acting as needed to sustain the economic expansion have been removed. As with the previous cuts in this cycle, two FOMC members voted to keep rate unchanged. We will doubtless not have to wait long for Trump to take incoherent potshots at Powell and his colleagues. 

Earlier today in Ottawa, the Bank of Canada issued a more detailed than usual release of its own to explain its decision not to cut rates just yet.  Its case for staying on the sidelines rests on the combination of steady growth, which is expected to further narrow the already modest output gap in the next two years, inflation right at the 2 percent target level, and some evidence of rising wage pressures.   

The Bank sees the risks to this baseline forecast coming mainly from "Ongoing trade conflicts and uncertainty (which) are restraining business investment, trade, and global growth."  Strikingly, given the angst in Western Canada in the wake of the recent election, the Bank makes no direct reference to the sorry state of the energy sector, although it does acknowledge the fall in commodity prices generally. 

Interestingly, the last three words of the release are "fiscal policy developments". Justin Trudeau's Liberals promised in their election platform to run significant budget deficits throughout their mandate.  With the Liberals now dependent on the even more deficit-friendly NDP in the new House of Commons, fiscal policy may become a significant source of stimulus in the months ahead.  Governor Stephen Poloz and his team are right to signal that this can and must influence the direction of monetary policy.

With that said, it is hard to see how the Bank will be able to stand aloof from the global easing cycle for much longer.  Canada now has the highest official rate target in the developed world, and the currency is moving higher as funds flow into the country to take advantage. In the meantime there is growing media speculation about an economic slowdown, and not just in the energy sector: both Ford Motor Company and General Motors will shortly be slashing employment in Ontario.  A rate cut during the next three months seems to be a safe bet, most likely when the Bank releases its next updated Monetary Policy Report in late January.