BoC Decision: Sights Now Set On October Hike

After increasing the overnight rate target by 25 basis points in mid-July, the Bank of Canada kept its target for the overnight rate at 1.50% this morning.

The first takeaway from the statement is that the gradual tightening process promoted by the BoC remains intact: “Recent data reinforce Governing Council’s assessment that higher interest rates will be warranted to achieve the inflation target. We will continue to take a gradual approach, guided by incoming data.” The second takeaway is that a 25-basis-points hike at the Oct. 24 meeting is the most likely outcome due to the increasing evidence of improving economic conditions. As noted in today’s statement, “business investment and exports have been growing solidly for several quarters,” “activity in the housing market is beginning to stabilize” and “continuing gains in employment and labour income are helping to support consumption.

Also, the BoC wanted to share its interpretation of the solid 3.0% y/y total CPI inflation data for the month of July. In our view, the BoC said that it was not going to deviate from its gradual tightening process because of a transitory relative price change caused by the surge in airfare prices. The BoC expects total CPI inflation to ease toward 2.0% y/y in early 2019, where are sitting core CPI measures.

Finally, “The Bank is also monitoring closely the course of NAFTA negotiations and other trade policy developments, and their impact on the inflation outlook.” This addition to the statement implies a slightly growing concern of trade developments for BoC officials. This slight dovish tint reflects the low odds of a new NAFTA deal and also that the U.S. White House could soon announce new punitive tariffs on $200 billion of Chinese imports. Both the U.S. and Canada will likely need to show flexibility on sensitive issues, including the dispute resolution mechanism and the dairy supply management, to reach a new NAFTA deal. If a deal in principle is reached, economic activity could be modestly stronger-than-expected. According to the July MPR, trade policy uncertainty is expected to shave a cumulative 0.7pp on real GDP growth by the end of 2020. It this estimate turns out to be right, it would not make a tremendous difference in determining the timing and number of hikes for the next 18 months. Finally, if Canada and the U.S. are unable to find common ground, NAFTA 1.0 remains in place while the U.S. White House tries to push its bilateral trade pact with Mexico to U.S. Congress. This scenario would not automatically prevent the BoC from continuing the gradual removal of monetary policy accommodation.

Bottom Line: We forecast a 25-basis-points policy rate increase in October, followed by two 25bps hikes in 2019.

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