The Bank of Canada met today and kept the overnight lending rate unchanged at 1.75%. There was a strong reaction in the bond market to the changes that were made to the outlook of the domestic economy within the BoC’s statement and Monetary Policy Report. Below is a selection of the key changes, as well as a review of the market reaction.

 

i. Removal of any hiking bias from statement. Within the statement the governing council noted that “an accommodative policy interest rate continues to be warranted” and that they “will continue to evaluate the appropriate degree of monetary policy accommodation as new data arrive.” The housing market, oil markets, and global trade policy are key areas they are focusing on to see if their fresh forecasts are on track.

 

ii. Changes made to growth forecasts. The BoC revised down their forecast for economic growth this year to 1.2% (from 1.7%), notably below their estimate for potential growth. The economy is expected to rebound in 2020 with growth of 2.1% while the BoC also included the first forecast for 2021 GDP growth, at 2%.

 

iii. The composition of growth is hopeful. The governing council modestly reduced the expected contributions to GDP from personal consumption, housing, business investment, and exports this year. They expect a large rebound in both business investment and exports next year, as well as smaller improvements in housing and personal consumption, which will lead the rebound in GDP growth and the reduction in the output gap.

 

iv. Estimated output gap has widened. In January the BoC forecast that the output gap was -0.5%. Their expectations are that the gap is now -0.75% which is reflective of the Business Outlook Survey results which showed that companies are less capacity constrained and the slowdown in growth has persisted longer than anticipated.

 

v. Potential growth was reduced. In the only hawkish move, although for the wrong reasons, the BoC lowered the potential growth rate of the economy to 1.8%, from 1.9% in January. This level of growth is the yardstick to compare to going forward. Any level of growth below this level, we can expect the output gap to widen further. Growth above potential (what the BoC are expecting later this year and next), would narrow the output gap.

 

vi. The neutral rate range was lowered. The governing council reduced the forecast neutral rate range by 25 basis points to 2.25% - 3.25%. All else equal, this means that the current stance of monetary policy (1.75% o/n) is tighter than previously expected.

 

Market Reaction: Government of Canada bonds went up modestly after the release of the statement. They had already started the day higher than yesterday, so it has been a positive day for government bonds but not for the market’s views on the economy. The Canadian dollar is down ~0.35% against the U.S. Dollar with the currency pair trading at 0.7410 (1.3449 USD/CAD).

 

Please let us know if you would like to discuss how this news impacts your portfolio. As always, we welcome your thoughts and questions. We look forward to having a conversation.

 

Samuel Gorenstein, MBA | Gorenstein Wealth Management Group  |  Vice President  & Associate Portfolio Manager

samuel.gorenstein@rbc.com