Poloz Gives Nod to Recovery Amid ‘Encouraging’ Economic Data

(Bloomberg) -- The Bank of Canada gave a nod to improving economic data in a shift that appears less dovish after almost two years of unchanged interest rates.

Poloz Gives Nod to Recovery Amid ‘Encouraging’ Economic Data

Stephen Poloz

Photographer: David Kawai/Bloomberg

While Governor Stephen Poloz left the benchmark interest rate at 0.5 percent Wednesday, he added new language stating “the current degree of monetary stimulus is appropriate at present.” Policy makers also said Canada’s adjustment to the oil price decline is “largely complete” and that “recent economic data have been encouraging” -- with a “robust” labor market driving consumer spending and housing.

The language represents a slight change in tone for a central bank that up to now has been downplaying the recent run of strong data -- pointing instead to persistent slack in the economy, especially relative to the U.S., as well as emerging geopolitical risks. Yet, it’s become a tenuous stance as economic numbers show a robust rebound.

“The main message is that the bank now clearly sees the balance leaning more to the side of raising rates, rather than cutting them,” Doug Porter, chief economist at Bank of Montreal, said in a note to investors. “Still, we expect that such a move is a long way off and continue to look for the Bank to keep rates unchanged well into next year.”

Poloz Gives Nod to Recovery Amid ‘Encouraging’ Economic Data

Doug Porter

photographer: Norm Betts/Bloomberg

The Canadian dollar jumped on the report, gaining 0.5 percent to C$1.3452 per U.S. dollar at 12:22 p.m. in Toronto.

The country’s currency has fallen about 20 percent since oil prices began declining in 2014, and has continued to under-perform this year as Poloz talked down the likelihood of rate increases even as the Federal Reserve moves ahead with higher borrowing costs.

Poloz Gives Nod to Recovery Amid ‘Encouraging’ Economic Data

Swaps trading suggest that investors are pricing in only a 21 percent chance of a rate increase at the Bank of Canada this year. The difference between the two-year yields of Canadian and U.S. government bonds is at about 0.6 percentage points, the highest since before the financial crisis.

That’s even as the country’s economy is running at what seems to be the very high end of growth levels. The Bank of Canada projects that output expanded at an annualized pace of 3.8 percent in the first quarter, building off a 3.2 percent expansion in the second half of last year -- well above U.S. levels. Still, all the concerns the bank has been highlighting in recent months remain in its latest statement, including forecasts that Canadian growth will moderate in the second quarter and U.S. growth will speed up.

While the bank was a “little more upbeat,” the likely path of Canadian rate increases isn’t likely to change, according to Mark Chandler, head of fixed income research at RBC Capital Markets. “The changes are very subtle,” he said. “I’m not sure it’s much of a departure at all.”

Wednesday’s statement had nothing to say about financial stability issues related to Toronto housing -- where runaway prices and troubles at mortgage lender Home Capital Group Inc. have dominated concerns in the Canadian economy -- other than to note recent regulatory tightening has yet “to have a substantial cooling effect on housing markets.”

For years, the central bank’s position has been that interest rates are ineffective instruments to counter financial imbalances. According to National Bank of Canada economists, Poloz may be signaling he is reconsidering that policy.

The statement “suggests that, if the resale market does not soften, the central bank may decide to complement macro-prudential measures with rate hikes in an attempt at restraining the rampant housing market,” National Bank economists Paul-Andre Pinsonnault and Krishen Rangasamy said in a note to investors.

Key Points

  • The Bank of Canada reiterated its assessment that subdued inflation and wage growth is consistent with “ongoing excess capacity in the economy.” Still, even here the language is seen as more dovish, given the previous statement spoke of “material excess capacity.”
  • Critically, it changed its policy language to add a time element and the word “stimulus.” In the April 12 statement, that language had been that “Governing Council judges that the current stance of monetary policy is still appropriate.”
  • The last time it used the “current degree” of stimulus language was in the May 2015 statement, which immediately preceded a July 2015 rate move -- which was a cut at the time.

Other Details

  • No indication of how U.S. economy is diverging from Canada’s economy, which has been something highlighted in the recent past.
  • The bank calls inflation consistent with April projections, with decline in food prices temporary because of intense retail competition.
  • Global economy gaining traction, with growth strengthening and broadening, the bank says.
  • Policy makers see the first-quarter slump in U.S. growth as temporary.
  • Canadian export growth remains subdued, as anticipated.
  • Strong Canada growth in the first quarter will be “followed by some moderation.”