The Bank of Canada may not be done with interest-rate cuts just yet.
Seven of 19 economists in a Bloomberg survey predict the central bank will lower borrowing costs at some point in 2016, with the rest forecasting it will stay on the sidelines. The next decision is March 9.
Although bond markets are pricing out the chances of more monetary stimulus, the divergence among forecasters highlights a number of uncertainties in the country’s economic story: The currency has depreciated dramatically over the past two years, but it’s unclear if the decline is sufficient to revive manufacturing. The federal government is promising fiscal stimulus, however details are unavailable until the March 22 budget.
“A rate cut remains on the horizon,” said Thomas Costerg, New York-based senior economist at Standard Chartered Plc, who was the first to call Canada’s slowdown last year. He forecasts the benchmark rate will be cut to 0.25 percent in July, from the current 0.5 percent. “It’s really difficult for Canada’s growth to take off even with a weaker currency.”
Costerg joins economists at the Bank of Montreal, Capital Economics, Macquarie Capital, Citigroup Inc., HSBC Bank Canada and Laurentian Bank in predicting more stimulus from Bank of Canada Governor Stephen Poloz. It’s a view that assumes the impact of the oil shock will persist, and Canada’s non-energy exporters will continue to struggle.
It’s also a view increasingly at odds with bond markets, which are pricing out chances of additional monetary stimulus. Odds of a rate cut in 2016 fell to about 38 percent on Friday, from double that in January, according to Bloomberg calculations on overnight index swaps. Poloz quashed rate-cut expectations at his last decision on Jan. 20, partly because he’s waiting to see details of the government’s fiscal plan.
A return to an easing mode — the Bank of Canada cut borrowing costs twice last year — would spell the end of the Canadian dollar’s recent recovery. Since the January rate decision, the dollar has gained 9.2 percent against its U.S. counterpart, making it the top performer among the world’s most-traded currencies. It had fallen 25 percent in the two years prior to that.
Yields on Canadian two-year bonds have almost doubled since January to 0.53 percent Friday, narrowing spreads with equivalent-maturity U.S. debt to 35 basis points, from as high as 59 basis points. That tightening too is bound to reverse if Poloz cuts again, or fails to match any future rate hikes by the U.S. Federal Reserve.
Reasons cited for the Bank of Canada to stay on the sidelines include a partial recovery in the price of oil, one of the country’s largest exports, and stabilization of global financial markets. The new government under Prime Minister Justin Trudeau is planning one of biggest one-year expansionary swings in fiscal policy in the nation’s history, hinting at deficits of about C$30 billion ($22.4 billion) this year. There’s also an increasing sense in global policy making circles that central bank effectiveness is reaching its limit.
None of that is persuading skeptics like Costerg and Doug Porter at Bank of Montreal. For one, the recent gains in the dollar should be a new concern for Poloz given the importance of export growth in his rebound story. The central bank governor in January cited the risks from the rapid depreciation of the currency as among the reasons for not cutting interest rates at the time.
“Suffice it to say the currency is no break on the Bank of Canada anymore,” said Porter, chief economist at BMO Capital Markets, which is alone among the country’s top five banks forecasting a cut this year.
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Investment in the nation’s oil industry will continue to be a drag on growth, even if prices recover, said Costerg, who first cut his forecasts for the Canadian economy in January 2015, six months before most of his peers adjusted, on the back of worries about the Canadian crude sector. He has been pessimistic about Canada’s prospects since.
“We just did the math,” Costerg said of his forecasts last year. “We had the view that the drop in oil prices was a big shock to the economy given the size of the energy sector.”
David Doyle at Macquarie Capital, which predicts the Canadian dollar will fall to a record low of 59 U.S. cents next year, cites three main reasons why he thinks the Bank of Canada is too optimistic and will likely cut rates: exports probably won’t recover as robustly as expected, rising import inflation will eat into consumer budgets and government spending is unlikely to have the hoped-for impact, partly on delays getting money out the door.
“We continue to think that the Bank of Canada and consensus growth forecasts for the domestic economy are too optimistic,” Doyle said in a phone interview. “We think a lot of people have become more constructive on the outlook based on a couple of things which there is not much evidence occurring yet, the first being a pick up in export activity.”
Other areas of concern include stretched home valuations and worries the oil shock could spill over into consumption, an area of strength for Canada. There are also doubts about the country’s ability to benefit from a weaker dollar. The close correlation between the currency and manufacturing doesn’t seem to mean as much as it has in the past, possibly suggesting deeper issues for the Canadian economy with the emergence of stiffer competition from countries like Mexico.
David Watt, chief economist at HSBC Bank Canada, believes it’s too early to give up on monetary policy. “Too much is being placed on fiscal policy,” said Toronto-based Watt. “We still need a mix of fiscal and monetary.”
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