How central banks will respond to slower growth

Slower growth in Canada and the U.S. will mean a less aggressive rate-hiking schedule from central banks, which could also impact the Canadian dollar, says CIBC deputy chief economist Benjamin Tal.

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“The Bank of Canada has been relatively hawkish recently but I think they will change their language soon,” Tal said in a Nov. 19 interview. “Clearly, the Canadian economy is not booming.”

Canada’s GDP grew at an annualized pace of 2% in the third quarter, down from 2.9% in the second. Inflation numbers for October came in above expectations at 2.4%, while core inflation was right on the BoC’s 2% target.

Tal said inflation isn’t rising “in any significant way.”

The price of oil, especially heavily discounted Alberta oil, will limit economic growth, he also said, pointing out that oil from that province is trading at a lower price than it was when the central bank cut interest rates twice in 2015. The difference between Western Canadian Select and West Texas Intermediate hit a record US$50-per-barrel last month, before the gap started to shrink.

Read: The road ahead for Canadian oil producers

“This is not an environment in which the Bank of Canada can raise interest rates in a very aggressive way,” Tal said.

In November, he forecast the central bank “moving once, maybe twice from this point before calling it a day. That’s very significant because, at this point, the market is expecting more than that and I think that the Bank of Canada will take its time.”

That would have a positive impact in limiting any “shock” to the housing market from higher rates, he added.

It’s not good news for the loonie, however. With the Fed potentially moving faster than the BoC and oil prices dragging, Tal said the Canadian dollar could lose another cent or two before stabilizing.

“The story for 2019 is a very dovish, very subdued hiking cycle by the Bank of Canada and therefore not a very strong Canadian dollar,” he said.

Tal also expects the Fed to deviate from its current trajectory of raising rates 25 basis points roughly every quarter.

“I suggest the Fed will stop much earlier than the market is currently anticipating,” he said. “The reason is that the fiscal stimulus that now is supporting the economy—by mid-2019, early 2020—will turn into a negative force.”

The Congressional Budget Office said in April that even though the tax cuts passed in late 2017 by U.S. Congress have driven growth this year, they’ll result in a projected cumulative deficit of US$11.7 trillion for 2018 to 2027, which will slow GDP growth.

For the U.S., Tal forecast GDP growth of 2.9% for 2018, 2.2% in 2019 and 1.4% in 2020. The Fed may have to cut rates in 2020 to respond to slowing growth if it doesn’t stop its hiking cycle earlier, he said.

The Fed’s most recent projection is for a fourth rate hike this year in December, followed by three more in 2019. In a speech last week, Federal Reserve Chair Jerome Powell said future hikes aren’t on a “preset policy path,” and the central bank’s Nov. 7-8 meeting minutes affirmed this outlook.

In Canada, Tal expects 2018 GDP growth to come in around 2.1%, dipping to 1.8% in 2019 and 1.3% in 2020.

“We don’t see a recession in 2019 but clearly we see a softening in economic activity,” he said.

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