Three is a crowd

After two successive rate hikes, the Bank of Canada (BoC) left the target overnight rate unchanged at 1.0% at today’s monetary policy meeting. The pause in rate hikes had been anticipated by most of the market.

The statement released today by the BoC expressed that the current overnight rate is appropriate given the economy has shown some signs of moderating from the much stronger pace seen during the summer months. Real GDP growth was estimated to be 3.1% in 2017 and gradually slowing to 1.5% in 2019. Inflation was described as having picked up this year and is expected to rise to 2% in the second half of 2018, a little slower than the BoC previously expected. Exports and business investment were described as making solid contributions to current growth. However, the Canadian dollar has appreciated more than the BoC expected, leading to slower growth in exports in the future. The housing market and consumption are expected to show signs of slowing in light of previous rate hikes and policy changes.

While confident that growth will continue, the BoC indicated there are several downside risks to their outlook. Those areas center around inflation continuing to develop more slowly than expected, the degree to which there remains excess capacity in the economy, softness in wage growth, the economic effect of higher interest rates given elevated household debt levels, and the difficulty in renegotiating the North American Free Trade Agreement (NAFTA). The BoC indicated it will continue to monitor these issues in determining the appropriate path of monetary policy.

We believe the BoC appears satisfied that the current level of rates gives it the flexibility to be cautious in making future changes to the policy rate. Canadian 10-year rates peaked at 2.13% earlier in October and should find it difficult to move much higher unless global central banks become much more aggressive in tightening monetary policy. The existing environment should continue to be positive for both Canadian bonds and equities, but may prove more difficult for the Canadian dollar.