BoC Rate Hike On Wednesday Unlikely

We expect the Bank of Canada to keep the overnight rate unchanged at 1.25% on Wednesday, assuming it is still preferable for Governor Stephen Poloz to lean against the threat of trade protectionism. According to the quarterly released last week, 21% of Canadian firms see an unfavorable impact of U.S. policies and uncertainty on their current operations, compared to only 9% observing a positive impact. Furthermore, a preliminary NAFTA deal including unresolved issues, such as the government procurement and the sunset clause, is unlikely to significantly brighten the Canadian outlook. Moreover, recent data suggests that the B-20 measures are negatively affecting the housing market and economic growth.

This being said, the case for a rate hike, for later this summer, is gradually coming together. Total and core CPI inflation figures have been generally increasing in tandem with the improving economic momentum, even though the minimum-wage hike in Ontario led to a surge in restaurants prices in early 2018. Core inflation is on target and total CPI inflation is slightly above target (2.2% in February). We expect Friday’s to show a robust 0.3% m/m increase in total CPI for the month of March following 0.7% and 0.6% back-to-back monthly surges in January and February (we also forecast a robust 0.8% m/m increase in for the month of February; this data will also be released on Friday morning). Real GDP growth is expected to remain above potential in the coming quarters. Thus, we forecast total CPI inflation accelerating near 2.5% during the second half of 2018 and 2019 Q1, more than enough to bring BoC officials to discuss the necessity to raise rates again.

Furthermore, the recent LFS and SEPH job reports indicated further signs of acceleration in wage growth, another encouraging development. This improvement in disposable income will allow Canadian households to better cope with recent increases in interest rates. The latest data available shows a stable debt servicing ratio (principal and interest payments) of 14% for 2017 Q4, still a manageable level of financial stress. The ongoing improvement in disposable income should help Canadian households to cope with the recent and prospective increases in interest rates.

Bottom Line: Announcing a rate hike to Canadians would be a tough sell for Poloz given the elevated degree of global trade uncertainty and a recent slowdown in housing. Moreover, although it has not prevented Poloz to act in the past, recent communications from the Bank of Canada has not sent any credible signal to market participants that a rate increase is in the cards this week. However, the favorable domestic economic momentum and strengthening inflation are easily justifying a rate hike sooner than later. Based on this uneasy trade-off, we now expect, after staying put on Wednesday, that the BoC will increase its policy rate once in 2018, likely in early 2018 Q3. This should be followed by two additional hikes in 2019.

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