Don’t price in a rate cut just yet

Bank of Canada Governor Stephen Poloz may have opened the door to a future rate cut, but economists and investors aren’t rolling out the welcome mat for lower rates.

“Governing council actively discussed the possibility of adding more monetary stimulus at this time,” Poloz told reporters Wednesday.

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The BoC downgraded the country’s growth outlook yet again as it released fresh data that pointed to a dampened outlook for exports and real estate activity. It’s now projecting Canada’s real GDP to expand by just 1.1% this year, down from its July projection of 1.3%. For next year, the bank is forecasting growth of 2%, down from its previous call of 2.2%.

The central bank also held its interest rate at 0.5%, as widely expected. Poloz said the bank decided against further stimulus as it waited to see the effects of the new federal mortgage rules, infrastructure spending, and the U.S. election. He also cited exports, which have been underperforming this year, as reason for pause.

The bank said the economy would not return to full capacity until mid-2018, later than the late-2017 timeframe it had anticipated three months ago.

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CIBC economist Nick Exarhos said in a note that the BoC’s cut to its economic outlook was a warning to markets that a rate cut isn’t out of the question. “All told, a dovish statement from the Bank of Canada that should keep odds priced for another cut despite the recent strength in Canadian indicators.”

Poloz said as much at a press conference today, saying the bank could revisit its decision “in the coming months.”

But Darcy Briggs, a portfolio manager at Franklin Bissett Investment Management in Calgary, questioned the logic behind a cut.

“The Bank of Canada has one mandate: stable inflation. Not growth – inflation,” he said. “If you’re growing at 1%, the question is: how do you justify cutting rates when growth is positive and core inflation is running close to 2%?

“Other economies are at negative and zero rates, and they still have not been able to encourage growth,” he noted.

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He added that central banks’ forecasts have been losing credibility as they’ve consistently forecasted higher economic growth than has come to pass. Even with today’s downgrade, that could still be the case, TD Economist Brian DePratto said in a research note.

“We expect GDP growth in 2017 of 1.8%, 0.2 percentage points lower than the Bank of Canada’s updated forecast,” he wrote.

The bank’s latest monetary policy report blamed exports as a main contributor for the lower forecast, following weaker-than-anticipated performance and somewhat gloomier prospects.

“The outlook for exports remains subject to considerable uncertainty, which has significant implications for the economic projection,” said the BoC.

A rate cut would also do nothing to help Canada’s disappointing export levels, while undoing the federal government’s measures to tame the housing market, said TD.

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“Your desired effect of cooling the housing market, well you’re just lighting it back up, or partially back up,” added Briggs.

Poloz told reporters he doesn’t see the mortgage rules as an impediment to easier monetary policy. But he did say the bank underestimated the longstanding problems facing Canada’s export industry.

“More of our export shortfall may be structural, rather than cyclical,” he said. While global and U.S. demand has been weak, there are other problems, including a global surge in protectionism, uncertainty surrounding regulation and trade deals, and higher production costs.

“There’s finally an acknowledgement from the Bank of Canada that it’s not just a currency problem that Canada’s exports are facing,” Briggs said. “It shows that a weaker currency is not a panacea for global demand.”

“Our view is that they’re saving their bullets for when they really need them,” he said.

The bank’s rethink suggests it will hold the rate as is, as cutting it would lower the Canadian dollar, with no assurance it would help exporters.

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“It’s been a sub-par, muddle-along recovery,” Briggs said, but that’s not unusual. Historically, it takes seven to 10 years after a downturn as sharp as the financial crisis for the economy to return to full capacity.

RBC deputy chief economist Dawn Desjardins wrote in a note to analysts that the bank’s economic downgrade has brought its projections closer to the mainstream consensus.

She expects the economy to eventually transition to sounder footing, and that “downside risks will remain at bay.” This “augurs for the Bank to hold the overnight rate steady.”

The challenges to exports, the oil sector and real estate do tilt the bank toward a cut, but the threshold for monetary easing is high, said DePratto. “Governor Poloz will likely be happy to sit on the sidelines for some time to come.”