April 12, 2023 | 11:31
Bank of Canada: Holding Pattern
The Bank of Canada held its key overnight lending rate steady at 4.50% for the second meeting in a row, and looks to remain on hold for some time yet. The tone of the statement was relatively balanced, as the Bank seems quite comfortable on hold.
While there was little suspense surrounding today's Statement, the Bank's revised economic and inflation forecast had some wrinkles. Even with lighter-than-expected flat GDP growth in Q4, a solid start to 2023 has boosted this year's growth estimate 4 ticks to 1.4% (we're at 1.0%). The global growth backdrop is better than expected, though the Bank continues to look for a slowdown in the coming months (both globally and domestically), citing the lagged effects of rate hikes as well as the recent banking sector strains. Governor Macklem said in the press conference that the economy needs a period of cooler growth to corral inflation, although the Bank's forecast does not include an outright recession. The BoC notes ongoing excess demand in Canada, and while Q1 GDP was above its forecast, it still expected growth to be "weak through the remainder of this year". Earlier rate hikes are anticipated to have an increasing impact on the economy, with the MPR detailing mortgage renewal dynamics. In fact, a weaker consumer spending and export outlook has prompted a 5-tick downgrade in next year's growth forecast to 1.3%, matching our call (but the Bank now has growth lower in 2024 than 2023). With consumption poised to cool meaningfully, this "implies the economy will move into excess supply in the second half of this year". The latter is despite a cut to potential growth estimates, suggesting the BoC could eventually be open to easing if inflation slows below 3%
However, that's a big "if", and the BoC remains acutely concerned about inflation. Wages are again noted as rising faster than productivity, even as labour shortages are starting to ease. Headline inflation is still expected to fall to 3% around mid-year, and it shaved the year-end estimate by 1 tick to 2.5%, with a slow move to 2% by the end of 2024. Another mildly dovish remark: "Recent data is reinforcing Governing Council’s confidence that inflation will continue to decline in the next few months." But that's promptly offset by concern that getting "the rest of the way back to 2%" could be a challenge. The BoC highlights that it will be focused on services price inflation, wage growth and core inflation in deciding on policy.
On the policy outlook, the Statement repeats the phrase that the Bank "remains prepared to raise the policy rate further if needed", and adds that it is assessing "whether monetary policy is sufficiently restrictive to relieve price pressures".
A couple sidebars: On fiscal policy, the Bank estimates that overall additional fiscal spending of $25 billion per year has been added since the January MPR (i.e., during this year's Budget season). That works out to almost 0.9% of GDP, which is even north of our estimate, and simply drives home the point that generally generous budgets this year are working at cross purposes with the Bank's restrictive policy—at the margin, further pushing back the day when the Bank can begin cutting rates. And another item keeping inflation pressures aloft, at least in the Bank's view is "corporate pricing behaviour", which is at least a small nod that wider margins have been one driver of inflation in the past year.
The April MPR contains the Bank's annual estimates of potential growth and the neutral interest rate. On the latter, there is no change whatsoever at a 2%-to-3% range, even with the historic run-up in rates and inflation over the past year. The mid-point of that estimate (2.5%) is basically derived from the Bank's 2% inflation target plus a 0.5% real rate. There was a much more significant move in potential growth estimates, however, with the estimates slashed—including a 1 ppt cut to this year to 2.3%. The medium-term outlook is now pegged at 2.2%, with trend labour force growth of 1.3% (close to underlying population trends) and productivity of 0.9% per year. While the latter is in line with the long-term history, it looks high versus the past five years.
Bottom Line: The BoC is comfortably on hold for the time being with inflation slowing in line with its forecast. The Bank's expectation that the economy will be in excess supply by the second half of the year opens the door a crack to potential easing later this year if inflation continues to slow, but there's still a lot of wood to chop on that front. In fact, the Governor explicitly stated in the press conference that market pricing of rate cuts later this year isn't the most likely scenario. We continue to expect the Bank to remain on hold until the end of 2023 before rate cuts begin in earnest in 2024.