After a Weak Q4, the Economy Appears to Be Meeting Modest Expectations….
After a weak Q4 GDP, the BoC delivered a clearly dovish shift in its March 6 statement, ceasing to look for rates to rise to neutral. However, that the BoC noted “increased uncertainty over the timing of future rate increases” still implied that the next move was expected to be a hike.
Since the statement, January GDP saw a stronger-than-expected 0.3% increase, implying that the BoC’s 0.8% annualized Q1 GDP forecast could be modestly exceeded. Employment slipped in March but after two strong months, trend remains positive. Wage growth has even picked up a little, though remains subdued at 2.3% y/y. Core inflation is slightly below the 2% target. We expect respectable GDP growth to resume in Q2, with the recent budget providing a marginal fiscal boost.
…but the Bank of Canada Seems to Have Moved Away From a Tightening Bias
However, Poloz recently stated that it is not helpful to focus on the neutral rate, which is not a target. This implies a further downgrading of the bias to move rates higher, with tightening likely to require a spell of above-potential growth to close the output gap again after a recent widening, returning inflation to target. Even with a return to respectable growth, we expect the output gap will persist through 2019. Continued solid growth in 2020 will likely be enough to push rates a little higher, however, by 25 bps in Q2, to 2.00%.
Risks to the View
The BoC is data dependent, and a faster-than-expected closing of the output gap could bring tightening forward, while lack of progress could mean no tightening at all. Escalation of trade tensions with the U.S., or a renewed slide in the oil price, could shift the bias toward easing.