Odds on Canada to Follow Fed’s Rate Cut: Decision Day Guide

(Bloomberg) --

The Bank of Canada is poised to follow the U.S. Federal Reserve and cut interest rates in the face of rising coronavirus concerns.

All odds point to Governor Stephen Poloz lowering interest rates by at least 25 basis points on Wednesday after global coronavirus fears spooked markets and sent oil prices tumbling. Canada’s central bank has managed to hold rates steady for almost 16 months, resisting a global easing trend. Now, after the Fed made an emergency half-percentage point interest rate cut Tuesday morning, Poloz may have no choice but to join in.

It’s a dramatic change from a month ago, when the most likely scenario was that Poloz would be able to keep the benchmark rate unchanged at 1.75% for the last few meetings before his term ends in June. Markets are now pricing 75 basis points of cuts by the time he steps down.

Here are some of the reasons why he’s seen cutting:

With the Bank of Canada already owning the highest policy rate among advanced economies, it’s unlikely it can resist the worldwide policy response to the fallout from the coronavirus and China’s slowdown. Canada’s outlier status on rates has already made its currency one of the best performing over the past 12 months, a luxury the nation can ill afford at a time when oil prices have fallen and its exports are slowing.

Group-of-Seven Finance ministers and central bankers, speaking on a conference call Tuesday, reaffirmed their commitment to act to protect their economies, but stopped short of any specific action. A few hours later, the Fed delivered an emergency rate cut. The Australian and Malaysian central banks were the first in the world to lower rates Tuesday at their scheduled meetings before the Fed’s emergency response.

Pressure for the Bank of Canada to act is only increasing. As of 2:30 p.m. Toronto time, markets were pricing in a 66% chance for a 50-basis-point cut. That’s up substantially from the start of trading Tuesday, when markets expected just one full 25 basis point cut, and no more.

Even before the spread of coronavirus, Canada’s domestic fundamentals were looking weak. The economy ended last year on a soft note, with the expansion stalling in the fourth quarter and economists predicting below potential growth to continue into the first half of this year. The country was also dealing with a made-in-Canada crisis as demonstrations by environmental and indigenous-rights activists crippled freight and passenger traffic across Canada for more than two weeks last month.

With slack in the economy already on the rise, many economists had been predicting a rate cut would be needed at some point over the next year. Reflecting this deterioration, the Bank of Canada took a dovish turn in January, highlighting concerns about domestic weakness persisting.

Terms of Trade

While Canada hasn’t had a large number of cases to contend with, its economy is expected to be hurt by what most expect will be a sharp markdown in global growth as a result of the virus. The slowdown comes as the nation’s trade sector has already been struggling, with growth in exports last year falling to the lowest since 2009.

The primary channel for Canada is through commodity prices. The Bank of Canada’s commodity price index -- which tracks commodities produced in Canada and sold in world markets -- is down 7.6% since the start of the year. World oil prices have fallen by almost a quarter since their 2020 highs. Western Canada Select, a type of crude that accounts for about half of country’s oil exports, is down 16% over that time.

Like other countries, Canada will also see a hit to travel and tourism, along with supply chain disruptions, economists said.

“That’s enough for them to cut on its own – the terms of trade shock, the travel and tourism, the supply chain disruptions from not being able to source inputs from China,” Royce Mendes, an economist at Canadian Imperial Bank of Commerce in Toronto, said by telephone.

Reasons for Holding

An interest rate cut this week would mark the first Bank of Canada action since October 2018, when it raised rates. A strong labor market and near-target inflation have given Poloz some reason not to cut. So did elevated household debt levels and a tight housing market. Another reason to hold off until April is that the decision comes without the broader analysis included in a Monetary Policy Report. The federal government budget, expected later this month, may also provide some additional stimulus that monetary policy makers would want to incorporate into their decision making.

Still, the global economic threat from coronavirus is enough to offset any of the domestic reasons why the Bank of Canada may hold.

“The rapid spread of COVID-19 globally, deterioration in financial conditions, steep drop in oil prices, not to mention continued transportation disruptions domestically are collectively too much for the Bank of Canada to ignore,” wrote National Bank Financial economist Warren Lovely in a note.

To contact the reporter on this story: Shelly Hagan in ottawa at shagan9@bloomberg.net

To contact the editors responsible for this story: Theophilos Argitis at targitis@bloomberg.net, Chris Fournier, Stephen Wicary

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