Poloz to Set Tone for Future Rate Increases: Decision Day Guide

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(Bloomberg) -- Almost nobody expects Bank of Canada Governor Stephen Poloz to increase interest rates at a policy decision Wednesday, but attention will turn to clues for the timing of the next hike as the central bank tries to steer an economy that’s beginning to run up against capacity.

All but two of the 23 economists surveyed by Bloomberg, including those from the country’s largest banks, predict the benchmark interest rate will remain unchanged at 1.25 percent. The central bank will also release new quarterly forecasts along with its decision at 10 a.m. in Ottawa, followed by an 11:15 a.m. press conference by Poloz and Senior Deputy Governor Carolyn Wilkins.

Here’s a rundown of what economists will be looking for.

The Outlook

Since the bank’s last monetary policy report in January, the economy hasn’t lived up to expectations. Exports were sluggish to start the year, and growth in the first quarter -- economists predict a 1.7 percent annualized pace -- was well below what the central bank had been looking for.

That means there’s less pressure on production capacity today than there appeared to be three months ago, which alone is probably enough to keep the central bank on hold.

All bets are off for May, however. Odds of a rate hike are closer to 50 percent, compared with 20 percent for Wednesday’s meeting, swaps trading suggests. Even if the bank reduces its estimate for 2018 growth, that doesn’t change the fact the rate of expansion remains faster than the rate of potential growth -- currently forecast by the bank at 1.6 percent.

“At this time, it seems clear the BoC would prefer to maintain some optionality by delaying the next rate increase, but we think the lack of spare capacity will soon become even more apparent,” economists Karen Reichgott and Zach Pandl of Goldman Sachs & Co. wrote in a note to clients last week. The bank “may have less room for a delay of future rate hikes than currently believed.”

Trade Uncertainty

Geopolitics have featured prominently in Poloz’s recent cautious narrative, and the picture remains mixed. Even with an improved outlook for North American Free Trade Agreement negotiations and the central bank’s own survey showing no major impact yet on business, there’s plenty of room for the governor to remain wary if he chooses.

Nafta worries have been overtaken by broader trade frictions as tensions mount between the U.S. and China. There is also an escalating dispute between provinces Alberta and British Columbia over a Kinder Morgan pipeline that has not only raised concern about the oil industry, but is also casting a pall over the investment environment for the country.

Inflation Uptick

What Poloz has to say about accelerating inflation will be closely scrutinized. This is new territory for the governor, whose biggest challenge so far in his tenure has been how to get inflation higher.

The pick up in prices, while mostly driven by base effects from soft numbers in 2017, coincides with rising wages. And with gross domestic product growth expected to remain above 2 percent for the rest of the year, it’s becoming more difficult for the Bank of Canada to brush off inflation increases as temporary.

“The thing that matters the most is what inflation is doing,” Jean-Francois Perrault, chief economist at the Bank of Nova Scotia, said in an interview. “Inflation has been rising quite significantly.”

Potential Growth

The April MPR includes the central bank’s annual reassessment of how much the economy can grow without fueling inflation, and any upward revisions to its potential growth rate forecast could signal policy makers are more at ease with capacity constraints.

Its current estimate is for potential to average 1.6 percent over 2018 and 2019. But Poloz has also talked about how strong demand could fuel investment and draw in underemployed workers, building the nation’s capacity to grow.

Neutral Rate

Another key variable in the central bank’s decision making process, the so-called neutral rate, could also be due for a change. Policy makers use the measure as a gauge for how stimulative the policy rate is. The bigger the gap between the actual rate and the neutral rate, the more stimulative the current policy. The smaller the gap, the fewer rate hikes policy makers would expect to make.

Canada’s relatively higher household debt levels have made the economy more sensitive to rate movements, suggesting the final resting place for borrowing costs should be lower than the central bank’s estimated range of 2.5 percent to 3.5 percent. That implies less scope to raise interest rates.

©2018 Bloomberg L.P.

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