The likelihood of a Bank of Canada rate cut is rising as markets await details of Prime Minister Justin Trudeau’s promised stimulus package for the Canadian economy.
Markets have begun pricing in a greater chance this week that the Bank of Canada will move to cut its interest rates sometime this year, with the overnight index swap market suggesting that about a fifth of participants now see negative interest rates by the end of 2016.
With growth faltering and likely to remain weaker than expected by the BoC, the probability of a rate cut has increased
Charles St-Arnaud, an economist at Nomura Global Economics, said Tuesday that while the Canadian economy desperately needs the stimulus, the central bank might be forced to cut rates the longer it takes details about the package to be revealed. Finance Minister Bill Morneau is not expected to table the budget until sometime between late February and the end of March.
“With growth faltering and likely to remain weaker than expected by the BoC, the probability of a rate cut has increased,” he said in a note to clients Tuesday. “Moreover, after almost two months in power, the announcement of the size and details of the fiscal stimulus by the new federal government are still being awaited and one could start to wonder if the economy can wait the months it will need for the impact to be felt.”
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Following strong economic growth during the summer months, recent data suggests that the Canadian economy is starting to stall again. Gross domestic product shrank by 0.2 per cent in October as manufacturing, energy and construction sectors all continue to contract.
The outlook this year doesn’t get much better. With oil prices continuing to hover around US$36 a barrel, and even lower in some cases, St-Arnaud said it is likely business investment in the oil and gas sector will decline 10 per cent this year if prices do not rise. That follows a near 20 per cent decline in 2015.
The Bank of Canada will hold its next interest rate announcement on Jan. 20, though governor Stephen Poloz will give a speech this Thursday in Ottawa that gives the market a clue on what policy tools he might deploy this year.
Poloz’s comments will follow a data release on Wednesday of Canada’s international trade balance for November, which will likely help paint a clearer picture about Canada’s economic health in the fourth quarter of 2015.
“This week’s data and a speech by Bank of Canada Governor Poloz may be the deciding factors in whether we maintain our call for no additional interest rate cuts,” said Dana Peterson, economist at Citi, in a note.
“Mixed data, further decline in oil prices, and limited fiscal stimulus implementation since the December policy meeting, all cast doubt upon our forecast for the overnight rate to remain at 0.5 percent through mid-2017, followed by tightening in the second half of 2017,” she added.
But while it is clear the struggling Canadian economy needs help, St-Arnaud says that a further interest rate cut by the Bank of Canada is not the help it needs.
“With the household sector already heavily indebted, it is hard to see consumers accumulating more debt to consume and push growth higher,” he said. “Or if they do, it would significantly increase the risks to financial stability.”
The trouble is, even with the federal government unveiling its stimulus spending soon, it will take time for its effects to filter down into the economy. That may put added pressure on the bank to act if economic data sours in the coming months.
“An announcement would have initial positive effects through its impact on expectations, but it takes time for effective fiscal policy to be planned and implemented, so it could be a while before stimulus enters the economy and multipliers kick in,” said St-Arnaud. “The longer the announcement of the fiscal stimulus is delayed the more likely the BoC will cut rates to provide a buffer.”
At the moment, St-Arnaud estimates there is a 40 per cent chance the Bank of Canada will cut rates in the first half of 2016 as the market awaits details of Prime Minister Trudeau’s fiscal package.