Bank of Canada maintains overnight rate, is cautious about future hikes

In its second rate announcement of 2019, the Bank of Canada (BoC) kept its overnight interest rate at 1.75%.

The central bank’s decision comes as no surprise and confirms dovish speculations by economists over the past few weeks, as economic growth in Canada nearly came to a halt in the last three months of 2018, and showed no signs of picking up before the BoC’s rate announcement.

A slower-than-expected economy, dampened household spending and persisting uncertainty about global trade are among the reasons cited by the BoC for its decision to maintain its current overnight rate.

The BoC’s move represents a far cry from the tone it had set in 2018, when it raised the overnight rate past 1% for the first time since the 2009 financial crisis. As the economy continued to grow steadily over the past year, the bank progressively raised the overnight rate to 1.75%, where it has stood since October. As recently as December, the BoC said that its inflation target — or ideal rate — was a “neutral range” of 2.5% to 3.5%.

The bank has now changed tack and seems to be in somewhat of a holding pattern. “With increased uncertainty about the timing of future rate increases, Governing Council will be watching closely developments in household spending, oil markets, and global trade policy,” the rate announcement read.
 

Slow economic growth

When the BoC last raised its overnight rate back in October, it was because the Canadian economy was looking fairly solid. The bank was only projecting a “temporary slowdown in late 2018 and early 2019.” As fall eased into winter, though, the economy started to change, too — growing by only 0.1% in the fourth quarter, which marks an annualized pace of 0.4%, according to Statistics Canada. The slowdown started to look more permanent.

“The slowdown in the fourth quarter was sharper and more broadly based,” the bank said. “Consumer spending and the housing market were soft, despite strong growth in employment and labour income.”

This is the slowest pace of quarterly growth in two-and-a-half years. The figure was also lower than economists had expected. While most commentators had anticipated a slow down following Alberta’s cuts to oil production in January, many had believed that the country’s oil-producing regions would be hit harder than non-oil-producing provinces.

“It is now much harder to make that case the current slowdown is just an oil-price story,” mortgage broker David Larock wrote on Monday.

Lingering uncertainty about trade is also slowing down the economy, said the bank. “While the sources of [economic] moderation appear to be multiple, trade tensions and uncertainty are weighing heavily on confidence and economic activity,” the announcement read. “It is difficult to disentangle these confidence effects from other adverse factors, but it is clear that global economic prospects would be buoyed by the resolution of trade conflicts.”

That said, the bank seems semi-optimistic about America’s recent decision to delay a tariff increase on Chinese goods and what that could mean for the global economy.

“...progress in US-China trade talks and policy stimulus in China have improved market sentiment and contributed to firmer commodity prices,” the bank said.

Another factor in the slowdown was business investment, which the bank said “fell short of expectations.” When businesses borrow money to invest in their own growth, the economy also benefits, since more jobs are created.
 

Managing inflation

The central bank adjusts its overnight interest rate — i.e., the rate at which it lends money to consumer-facing lenders, like banks — to manage inflation. When the economy is doing well, the BoC raises its overnight rate to make borrowing more expensive, which prevents consumers from spending recklessly. When the economy slows down and needs a push, the BoC lowers rates to encourage people to spend more money and stimulate the economy.

Inflation “eased” to 1.4% in January, largely due to lower gas prices, the bank said — and it anticipates the rate to stay low through most of 2019.

The current economic outlook can certainly be described as “slow.” However, few people expected the BoC to actually lower the overnight rate on Wednesday, since the bank’s rhetoric throughout 2018 suggested that it would be able to pull rates up to the inflation target. A cut so soon after a hike would be too volatile for the market — and the bank knows this. 
 

Dampened consumer spending 

One of the indicators of how well the economy is doing is how much money Canadians are spending. Towards the end of 2018 and into the new year, multiple financial organizations released reports showing that Canadian households are struggling with high debt loads, keeping up with loan payments and rising insolvency and delinquency rates — all of which put pressure on spending. Many commentators blamed the turn of events on the higher interest rates spearheaded by the BoC over the past two years.

“...Rising interest rates may be having a bigger impact on consumers than expected,” wrote Bloomberg’s Theophilos Argitis.

The country’s housing markets have also seen a significant slowdown over the past year, as the mortgage stress test introduced by the Office of the Superintendent of Financial Institutions at the start of 2018 made it harder for homebuyers to secure a mortgage.
 

Don’t expect a hike anytime soon

Economists say that only two aspects of the economy would have given BoC reason to consider a hike: encouraging growth in the labour and inventory sectors.

In February, Statistics Canada reported that 66,800 new jobs were created in January — far exceeding the 8,000 that economists had predicted. This could have given the BoC ammunition for a rate hike, potentially citing a strong economy. But clearly this bump in labour wasn’t enough to make up for the fact that the economy came to a near-crawl last year.

Another area of growth was inventories — e.g., manufactured goods that are ready for sale. While Argitis said that their growth was “the only thing that kept the nation’s economy from contracting” over the past several months, Larock was more cautious, warning that tracking inventory growth alone was “misleading.”

“While this output gets counted in Q4, it is really just future production brought forward,” he wrote. “Unless we see a surge in consumer spending and/or exports in early 2019, which is not yet evident, Q4’s inventory production will reduce our GDP growth in the quarters ahead.”

For now, it seems the BoC agrees. Its language in Wednesday’s announcement is guarded, and suggests that the overnight rate will not be increasing any time soon.

“Governing Council judges that the outlook continues to warrant a policy interest rate that is below its neutral range,” the announcement reads. “Given the mixed picture that the data present, it will take time to gauge the persistence of below-potential growth and the implications for the inflation outlook.”