January 21st of 2015 stunned investors and economists as the Bank of Canada lowered their key interest rate by a quarter of a per cent. Prior to that, since September of 2010 policy interest rates in Canada had remained unchanged and the Bank of Canada was perceived to have a more hawkish bias. The surprise announcement last January from the more fluid and accommodating Bank of Canada governor, Stephen Poloz, has lent way to a loonie that continues to struggle to find any degree of stability. As focus remains on the Canadian dollar (in light of recently falling below the key psychological level of 70 cents), the question for Canadians, will the bank of Canada cut again next week?
To go out on a limb, the greatest probability heading into this January announcement is, not likely.
Numerous bank economists made headlines in the financial press this week for their calls for the bank of Canada to cut rates next Wednesday. Unfortunately, it seems the recent unpredictability of Canadian interest rate policy has led to greater uncertainty for the country’s top forecasters. A crucial point as well, made by CIBC’s Avery Shenfeld was where we have a dozen Fed Governors and Regional Presidents making speeches on current policy in the US, in Canada we aren’t afforded the same luxury of voting members utilizing speeches to offer guidance to the market. This makes predicting the bank of Canada a little more difficult.
There are a few simpler reasons, however, why it is unlikely for the Bank of Canada to take action next week. The first is that we are heading into the newly elected Federal Liberal’s first budget. With downgraded forecasts for Canadian economic growth, and some sluggish indicators from the final months of 2015, pressure is beginning to mount on Canada’s progressive new regime. With anticipated plans for short term infrastructure spending to boost economic activity, the Canadian central bank has reason to stand aside and let the new government officially unveil some of their plans. Then, should they anticipate a need for further measures to stimulate economic activity, a subsequent rate cut could come by the spring.
The second reason the bank of Canada can afford to hold off on a rate cut next week is attributable to the Canadian dollar. It is no secret Governor Poloz has been a cheerleader for a weaker dollar. With an approximate 20 percent decline in oil prices to begin 2016, the loonie is down nearly four per cent against the greenback. The continued deterioration of the Canadian dollar is the natural stabilizer the country needs to adjust from an economy over reliant on the energy sector to one of non-energy export led growth. Investment bank Macquarie Capital recently updated their forecast for a 59-cent loonie by the end of 2016. The reason for an even lower dollar is they see that as the level required to fully transition Canada from being an attractive market again for foreign investment.
Given the Bank of Canada Governor has come across as a bit of a wildcard to date, I don’t think any option is off the table for next Wednesday. But the continued weakness in the Canadian dollar has prompted large inflationary pressures on Canadian consumers from grocery bills to consumer electronics. Also, the quick pace of deceleration in the loonie will only be exacerbated by another rate cut, and no policy maker looks to shock markets. With the timeline for a federal budget and a focus of increased government spending from the newly elected Federal Liberals, there is their potential to surprise with a larger than anticipated deficit. Accounting for the aforementioned factors, my guess is like the span between September 2010 and January 2015, the bank remains on hold, and the loonie even sees a bit of a relief rally.