The BoC is forecasting slightly higher growth this year, but with Donald Trump overshadowing the future of Canadian exports, the central bank is downplaying its previous story of a rotation to non-energy exports.
In a policy statement Wednesday, where the bank held its benchmark rate at 0.5% and confirmed its openness to a rate cut, the narrative of growing non-energy exports amid low oil prices had given way to one of higher energy prices and “significant” U.S. policy uncertainty.
While any kind of tax on U.S. imports is going to hurt Canada, the Trump administration isn’t clearly in favour of the Republican-proposed border adjustment tax, says Aubrey Basdeo, head of Canadian fixed income for BlackRock Asset Management. “The smoke signals seem to suggest […] this is going to have more of an impact on the flow of goods between Mexico and the U.S. than Canada and the U.S.,” he says.
“Yes, a rate cut remains on the table,” BoC Governor Stephen Poloz told reporters at a news conference in Ottawa, when asked whether a cut was discussed at the bank’s policy meeting.
Scotiabank Economics’ Derek Holt added in a note: “[T]he BoC remains open and willing to a cut. Obviously this is heavily conditioned upon how U.S. trade policy evolves.”
With concerns about export growth in the foreground, the BoC also acknowledged that inflation has been lower than anticipated since October, largely on falling food prices. Core inflation has been below 2%, “reflecting material excess capacity in the economy,” the BoC said.
It expects inflation to move closer to its 2% target in the months ahead as energy prices rise and the impacts of lower food prices dissipate. November’s Consumer Price Index reading was 1.2%, in the bottom half of the BoC’s inflation range of 1% to 3%.
Ignoring protectionism under Trump, the bank hiked its real GDP forecast for 2017 to 2.1% from 2.0% and maintained its 2018 growth forecast at 2.1%.
“Export growth will be limited by the recent appreciation of the Canadian dollar, alongside that of the U.S. dollar, vis-à-vis most other currencies,” the BoC said.
The BoC said Trump’s plan for fiscal stimulus would boost demand for Canadian exports and support Canadian business confidence, thought U.S. corporate tax cuts could weaken Canadian competitiveness. It acknowledged that “protectionist trade measures” (e.g., a border tax on U.S. imports) could have “material” consequences for Canadian trade with the U.S.
“We’ve heard a lot about protectionist sentiment lately. They’re not baking that in right now, but clearly they’re thinking about it,” TD economist Brian DePratto says. “That may be something that would be [large] enough to necessitate a rate cut.”
The appreciation of the U.S. dollar—recently reaching its highest level in nearly 15 years on a nominal trade-weighted basis—should help redistribute global demand, the BoC said.
Markets, positively reading the U.S. economy, have made higher portfolio outflows from 25 emerging markets including China, “contributing to a tightening in financial conditions in some of these economies,” the BoC said.
Basdeo sees capital flows returning to some of these regions if they surprise to the upside. The U.S. dollar could also challenge the Fed.
“There’s a limit to how strong the U.S. dollar can get before it starts to corrode, or have a negative impact on, growth. I think that’s what the Fed is going to pay close attention to,” he says, noting the Fed’s plan for a series of hikes this year. “There’s going to be this kind of tug of war between what the Fed would like to do and what the U.S. dollar is doing.”
The central bank indicated there’s room for crude prices to rise as the global market rebalances. It noted that benchmark WTI crude prices have recently averaged US$50, about US$7 higher than its price assumption in October.
“The rewriting of the exports story is going to be that energy prices are rising,” Basdeo says. “Exports and investment, particularly in the energy sector, is probably going to add about 1% to GDP in 2017.”
The BoC said: “Risks to the Bank’s oil price assumption remain tilted to the upside over 2017-18, since prices are still below levels likely required to support medium-term market rebalancing.”
The bank continues to see “significant slack in the labour market,” it said, and federal and provincial fiscal spending should support growth in 2017. The BoC forecasts the economy returning to full capacity around mid-2018.