How low will Bank of Canada go?

Will the Bank of Canada cut rates on Wednesday? Don’t be surprised if it does.

Robert Spector, portfolio manager at MFS Investment Management in Toronto, breaks down what we know in the run-up to tomorrow’s announcement and ranks the probability of the Bank’s main options:

• The latest sentiment we have on the Canadian economy from the Bank of Canada’s Business Outlook Survey through mid-December shows broad swaths of the economy slowing, beyond just the difficulties in the oil patch.
• As of now, a rate cut is not fully priced in. We would estimate that it is about 50% priced in (for January), meaning we could experience some volatility in the bond markets should the BoC cut on January 20. The market has priced in 75% odds of a rate cut by the March BoC meeting.

Read: Will recent oil developments shape BoC decision?

• With a new government promising future fiscal stimulus, there is still a chance the BoC will sit tight in January and buy time for markets to stabilize, yet hint at a March ease if conditions deteriorate. This would give the market time to more fully price it in.
• This would be consistent with what transpired in the U.S. in 2015; when rates finally went up in December it surprised no one.

Here are four potential scenarios to watch for tomorrow:

• Low probability: No rate cut and the BoC makes it clear that it has done enough already and that conditions haven’t worsened enough to meaningfully change its forecast for growth and inflation.
• Low probability: A cut of 25bps with clear language that this is as low as they are prepared to go, which is back to its lowest rates since the global financial crisis.
• Third, with a much higher probability, is a 25bps cut and clear communication of a course of action to stimulate growth, preventing the slowdown in energy from spreading beyond the oil patch. We would look for language that clearly states that BoC sees growth and inflation taking longer to reach its forecasted levels.
• Fourth, and equally likely as scenario three, the BoC remains on hold but makes it clear that it is cutting its forecasts. This gives it time to prepare the market for a potential March cut without any major disruptions.

“I believe that without stabilization in China and the U.S., it will become not if, but when for a cut, and then it’s a question of how low can we go,” concludes Spector.

Also read:

Op-Ed: Why another rate cut will fail

Bank would consider sub-zero rates in a crisis

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.