Canada dodges recession, but BoC still dovish

Canada’s economy has moved past the threat of a technical recession.

In today’s rate announcement, the BoC attributes that rebound to continued strength in non-resource sectors. As well, the central bank finds household spending will continue to boost economic activity.

However, in its Monetary Policy Report, the Bank says domestic growth will remain sluggish going into 2016. It’s calling for 1% expansion in 2015 and only 2% in 2016.

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For that reason, the central bank is standing pat on its overnight rate. And that decision comes as no surprise, says Prab Sagoo, associate director at Nasdaq Advisory Service in Montreal. “There was no expectation from the broader markets of a rate cut or rate hike. [The BoC] is still assessing the impacts of its previous rate changes. A third rate cut would have been a real shock to the market, and would have indicated significant troubles ahead.”

What’s interesting, he adds, “is [the Bank] is seeing positive flow-throughs from the previous cuts. Non-resource exports and markets are starting to perform a little bit better. So I wouldn’t expect another rate cut, unless other factors worsen outside of Canada.”

On the other end of the spectrum, Sagoo says a rate rise is also unlikely over the short term. “For now, the BoC will stand pat” while it monitors the U.S. and China. “If the U.S. continues to show significant strength, that will be beneficial for Canadian exports, and [would] give the BoC less reason to raise rates.”

But, “If China does stabilize, that may flow through to stronger commodity prices. In that case, we would see a rate hike sooner than a rate cut.”

Market reaction

Markets have largely remained calm on the back of the rate announcement, says Sagoo. “There was a little bit of weakness, but nothing material; the sharp declines seen this morning were external to the BoC, it seems. We did see a weakening in Canadian yields, though, which is reflective of the scenario of interest rates remaining low for longer.”

Read: Understand duration for better bond returns

Darcy Briggs, portfolio manager with Franklin Bissett Investment Management, says, “We’ve seen a pretty strong reaction in the fixed-income market. But that’s probably more of a global yield story. Where we’ve really seen a bigger impact in is the FX market, since the Canadian dollar has sold off considerably today, based on what has been perceived by foreign markets as a dovish [central] bank.”

He adds, “The technical recession and the worst of the oil shock is behind us, and their effects will dissipate with time. But that seems to be lost on the market.”

Read: Correction’s over, but most sectors still struggling

Following the rate announcement, experts suggested that the BoC may have cut its domestic growth forecast to dampen expectations of a future rate rise. Sagoo says, “The downgrade [news] was the biggest part of the [BoC’s] release, and we did see some weakness on the back of that.”

But, he mainly blames oil price weakness for the slash in growth forecasts. The Bank initially thought oil prices would be depressed over the short term, says Sagoo, “but the latest release states that we’ll see oil prices weakness for a little longer than expected. This will feature into economic expectations, especially for oil-producing regions, and will have a drag on such projections going forward.”

On the upside, housing, labour and economic data have all been stronger, he adds. So he expects more positivity from the BoC and markets going forward.

Read: What’s driving Canada’s housing price strength?

Will Trudeau’s victory impact monetary policy?

The BoC’s outlook is based on pre-election fiscal policy, says Doug Porter, chief economist at BMO, in a release. As such, “it makes no allowances for the hefty spending proposed by the incoming federal government.”

That’s worth noting, says Briggs, because Prime Minister-designate Justin Trudeau’s economic promises “are not trivial, and will have a notable impact because the new government is looking to run counter-cyclical fiscal policy.”

But, says Sagoo, the switch to a Liberal majority government likely won’t affect the BoC’s decisions over the short-term. “The proposed deficit expenditure and, particularly, the infrastructure spending by the new Trudeau government, will not play immediately into the Bank’s forecasts. Some infrastructure projects can take quite a while to get off the ground, so the Bank can’t call those expenditures a guarantee or quantify [their impact].”

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However, he adds, “if we start to see the Trudeau government really pushing through that [investment] over the next six months, we may start to see some verbiage from the Bank emphasizing its flow-through. But I don’t think they can put it into their projections yet.”

A word on the U.S. Fed

It’s ambiguous as to whether the U.S. Fed will hike rates next week, says Sagoo. “[But] the overall call is they will not hike [until] early next year, because international markets continue to be weak. We’ll see tomorrow what the ECB does regarding the introduction of quantitative easing. Plus, all economic data coming out of China continues to point to slow economic growth.”

Read: Fed worried about lag in China, emerging markets

Nonetheless, says Briggs, the BoC expects a jump in U.S. and global growth as the effects of low oil prices recede. “The U.S. Fed has also looked at increasing growth next year. But it’s interesting because other entities such as the IMF have actually revised 2016 [global] growth expectations downward.”

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