BoC says volatility abating

The Bank of Canada has kept its benchmark interest rate at 0.5% and said financial market volatility “appears to be abating.”

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Jeff Young, who manages income and dividend funds for Natixis Global Asset Management Canada, said he’s watching for surprises in global growth indicators. Canada has been a difficult place to invest in in recent months, but climbing Canadian stocks now indicate investors are lifting their short positions on the loonie and Canadian oil and gas.

“The interesting thing right now is to see whether this is going to transition into real demand,” Young said. “Then you’ll actually see that volatility start to resolve itself, hopefully to the upside, but whether that’s in the near term or a bit further out is still an open question.”

Young suggests there’s still more volatility to come, and is hopeful for positive global growth data. He’s looking at key indicators from China and the U.S., such as ISM manufacturing and non-manufacturing and economic surprise indices.

Like many observers, Young doesn’t expect the BoC to cut rates this year unless the economy takes a turn for the worse. Most economists surveyed by Bloomberg forecast no change in the BoC’s lending rate this year, while seven of 19 expect a cut. The BoC has held its benchmark interest rate at 0.5% since July after two rate cuts earlier in 2015 amid the oil price shock.

Raymond Kerzérho, director of research with PWL Capital in Montreal, said by email that his firm is favouring high-credit quality and short-duration fixed income assets “to keep portfolio volatility in check.” He adds: “Based on the prices of bankers acceptance futures,” the market expects short-term credit market rates to remain where they are for the year.

While Q4 domestic growth was higher than forecast and annualized inflation reached 2% in January, the BoC said upward pressures on inflation are likely to unwind in the coming months.

“From the Bank of Canada’s perspective, the higher inflation that we’ve seen is not a reflection of underlying domestic demand; it’s a reflection of the weak Canadian dollar,” said Frances Donald, senior economist for Manulife Asset Management. “In my view, the Bank of Canada is on hold for 2016.”

Donald said the BoC appears to be comfortable with the rebounding loonie, which has risen almost 10% since falling to a 12-year low in January. Oil prices have also risen, helping the S&P/TSX composite index overcome its drop in value this year.

The BoC said it will also be analyzing the Liberal government’s stimulus package—details of which will come in the federal budget on March 22—and incorporating it into the Bank’s April projections.

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Young said he will be watching the federal budget for how fast the government intends to roll out the infrastructure spending. “Is this money that’s going out now into shovel-ready projects, […] or is this going to be a multi-year thing that’s going to take some time to have [an] impact on economic growth?”

Thorsten Koeppl, an economics professor at Queen’s University, said in advance of the rate decision that inflation should continue to be the BoC’s guiding principle amid slow growth and a weak loonie.

“I don’t see that the inflation target is in danger either on the upward or on the downward [side],” he said. “We have to think about a long-term normalization and stabilization of monetary policy.”

The BoC is expecting the Canadian economy to shift away from the natural resources sector as the low dollar, monetary stimulus and stronger U.S. demand boost non-energy exports. It previously forecast economic growth of 1.4% in 2016 and 2.4% in 2017.

While business investment is “very weak,” employment is holding up and non-energy exports are gaining momentum, the BoC said on Wednesday, after trade data last week showed exports rising for the third month in a row.

The BoC added that “financial vulnerabilities continue to edge higher,” acknowledging financial risks related to households in energy-producing regions.

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