Bank of Canada - With risks on both sides, timing matters
The Bank of Canada eased as expected by 25bps to 2.75%, a level it sees as neutral. Given massive uncertainty clear forward guidance is impossible but they made no attempt to hide the gravity of the problem, Governor Tiff Macklem stating Canada is facing a new crisis from which the economic impact could be severe. Near term downside risk looks set to be the focus but the BoC will ensure that any price rise is short term.
The BoC states that it cannot offset the effects of a trade war, meaning a hit to output and a lift to prices is seen as inevitable. Its focus will be on the timing and strength of both the downward pressure on inflation from a weaker economy and the upward pressure from higher costs. The focus on timing as well as strength suggests that the immediate focus will be on supporting the economy, as seen in the latest easing. The economy is likely to respond to the trade war quicker than prices. However, if higher inflation feeds into medium or longer term expectations, the BoC will have to act against that.
The BoC conducted a survey of consumers and businesses and the economic findings look negative. 27% of consumers plan more precautionary savings and 11% less. On major purchases, 7% see more and 25% less. Business findings look even worse, with 40% reducing employment plans and only 2% increasing them, while 48% are reducing capital expenditure plans and only 9% increasing them. Business pricing plans do suggest tariffs will not be fully passed through. Around half expect to raise prices in response to tariffs, though of those, three quarters expect to pass on more than half of the tariff cost. Still, 47% expect an increase in prices charged to Canadian households with only 7% seeing a decrease. Consumer findings show 72% expecting the cost of living to be boosted while 11% expect a decline.
While noting that recent GDP and CPI data exceeded expectations, supported by past easing, the negative impact of the trade war is expected to be seen in Q1, despite a preliminary estimate for January GDP being for a healthy 0.3% increase. Warning signs that the recovery in the jobs market could be disrupted are seen, while wages are showing signs of moderation. The Bank of Canada will have to watch incoming data, but we expect rates to be cautiously lowered to 2.0% through the rest of the year, with one 25bps move in each remaining quarter. It is notable that Macklem said a 50bps move was not seriously considered at this meeting. If inflation fails to show a significant acceleration, easing could be more front loaded than we expect. The BoC expects CPI to rise to around 2.5% in March from 1.9% in January as a recent sales tax holiday expires.