The Bank of Canada (BoC) lowered the policy rate by 25 bps to 3%, now firmly inside the 2.25%-3.25% neutral rate band. The Bank also dropped forward rate guidance, adopting a neutral posture for maximum flexibility in the coming months.
The useless stuff:
Given the uncertainty around US trade policy, the Bank provided a forecast for the economy in the absence of tariffs.
- Inflation was expected to remain close to 2%.
- GDP was lowered to around 1.8% for the next couple of years to reflect a slowdown in population growth.
The point about ending Quantitative Tightening in the spring is a rehash of comments that the Bank has already made, although few expected it to be formally announced today.
Currency weakness reflects trade uncertainty rather than the interest rate differential. So far, it has not impacted the Bank’s decision-making.
It’s all about tariffs:
The Governor emphasized that a protracted trade conflict could depress GDP by up to 2.5% and increase inflation by 0.8%. That said, the economic outcome depends on three variables:
- The size and scope of tariffs imposed by the US.
- The size and scope of counter-tariffs imposed by Canada.
- The magnitude of fiscal stimulus from provincial and federal governments for adversely affected industries and people.
He stressed that monetary policy could not offset the loss in efficiency, production, and income. Fiscal policy would need to do the heavy lifting there. However, the Bank could make the adjustment process less painful (i.e., lower interest rates), where the larger the fiscal stimulus, the smaller the monetary stimulus required.
Reading the tea leaves:
Tariffs have the potential of raising inflation and lowering growth. We lean towards the Bank being patient with an inflation increase to assess whether it is a ‘one-time’ event or risks becoming a wage-price spiral. Given their bleak growth assessment, we believe that the Bank would likely be more concerned that weak growth leads to higher unemployment, which would temper wage growth. As such, the risk is tilted towards the Bank cutting rates below the bottom end of the neutral range.
