BOC Keeps Tightening Bias But Tones Down Hawkish Language

As expected, the Bank of Canada left the overnight rate unchanged at 1.00% and toned down the hawkish language, acknowledging that global economic growth has weakened and citing that "risks remain skewed to the downside." With regards to Canada, the BoC downplayed the Q1 GDP miss (came out at 1.9% versus the Bank's 2.5% estimate), stating that "underlying economic momentum appears largely consistent with expectations" although suggesting that "growth is less balanced" (with strong housing and weak exports). The BoC also dropped the reference to "the biggest domestic risk" (i.e. household debt), not that surprising given the importance of the worsening international situation on the outlook. The Bank now estimates that CPI inflation will fall below 2% "in the short-term" (reflecting lower oil prices than expected back in April's MPR), with core staying around 2%, while the economy continues to operate with a "small degree of excess capacity."

Bottom line:
The BoC statement kept its tightening bias but the less hawkish tone of the press release supports our view that rate hikes are not likely to come any time soon. Note that in the closing paragraph of the statement, the BoC kept the sentence "some modest withdrawal of the present monetary policy stimulus may become appropriate" but made it conditional to the economic expansion continuing and excess supply in the economy being gradually absorbed. That sounded less affirmative than the April statement which highlighted better than expected economic growth, improving household and business confidence and firmer underlying inflation. We continue to expect the BoC to stay on hold until next year. There are just too many risks to Canadian growth at the moment, both from domestic and foreign sources.

Here is the press release:
The Bank of Canada today announced that it is maintaining its target for the overnight rate at 1 per cent. The Bank Rate is correspondingly 1 1/4 per cent and the deposit rate is 3/4 per cent.

The outlook for global economic growth has weakened in recent weeks. Some of the risks around the European crisis are materializing and risks remain skewed to the downside. This is leading to a sharp deterioration in global financial conditions. While the U.S. economy continues to expand at a modest pace, economic activity in emerging-market economies is slowing a bit faster and a bit more broadly than had been expected. More modest global momentum and heightened financial risk aversion have reduced commodity prices.

Although economic growth in Canada was slightly slower than expected in the first quarter, underlying economic momentum appears largely consistent with expectations. However, the composition of growth is less balanced. In particular, housing activity has been stronger than expected, and households continue to add to their debt burden in an environment of modest income growth. Despite external events, business and household confidence has held up and domestic financial conditions remain very stimulative. The contribution of government spending to growth is expected to be quite modest over the projection horizon, in line with recent federal and provincial budgets. The recovery in net exports is likely to remain weak in light of modest external demand and ongoing competitiveness challenges, including the persistent strength of the Canadian dollar.

The Canadian economy continues to operate with a small degree of excess capacity. Total CPI inflation is expected to fall below 2 per cent in the short-term, as a result of lower gasoline prices, while core inflation is expected to remain around 2 per cent.

Reflecting all of these factors, the Bank has decided to maintain the target for the overnight rate at 1 per cent. To the extent that the economic expansion continues and the current excess supply in the economy is gradually absorbed, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate, consistent with achieving the 2 per cent inflation target over the medium-term. The timing and degree of any such withdrawal will be weighed carefully against domestic and global economic developments.

Information note:
The next scheduled date for announcing the overnight rate target is 17 July 2012. A full update of the Bank’s outlook for the economy and inflation, including risks to the projection, will be published in the MPR on 18 July 2012