The Bank of Canada remains dovish, but stops short of an easing bias

As was universally expected, the Bank of Canada held firm on its overnight rate, keeping it at 1.00%.

• There were a great deal of changes in the wording of the statement, relative to December, but the bottom line message and tone were unchanged. Consistent with Governor Poloz’s recent media statements, the Bank put the current weakness in inflation front and centre. It stated that it expects the path of inflation to be lower than previously anticipated, but that it will still return to the 2% target in about two years. Moreover, the balance of risks remain unchanged from October, stating that the risks from elevated household imbalances have not materially changed.

• In the Bank of Canada’s Monetary Policy Report (MPR), the forecast for world economic growth was left unchanged in 2014 (+3.1%), but was revised slightly up in 2015 (+2.7%). Weak inflation in advanced economies remains a concern; recent trends have primarily been driven by declines in global prices for food and energy. The near-term U.S. growth profile has been upgraded relative to the October MPR, reflecting broad-based strength in U.S. private demand and reduced policy uncertainty.

• The anticipated economic improvement in advanced markets – led by the United States – should lead to an improved performance for Canada’s exports. In Canada, real GDP is projected to rise from 1.8% in 2013 (up from 1.6%) to 2.5% in 2014 (up from 2.3%) and 2.5% in 2015 (down from 2.6%). The growth profile implies that the Canadian economy will return gradually to capacity over the next two years. Despite depreciating in recent months, the Canadian dollar relative to the U.S. dollar remains strong and will continue to create competitiveness challenges for Canada’s non-commodity exports. However, the Bank did highlight how the recent depreciation of the Canadian dollar should help to boost exports and, in turn business confidence and investment.

• Both core and headline CPI are forecast to remain around 1% in the first half of 2014, before increasing slowly and incrementally toward the central bank’s target, expected to be reached in “about two years”.

Key Implications

• Despite many changes to the statement’s wording, the Bank’s tune hasn’t changed. Nor has the likelihood of it moving towards a more explicit bias increased. The balance of risks also remains unchanged from October, when the Bank initially adopted a more dovish stance. We remain comfortable with our forecast for interest rate hikes to be a long way off on the horizon, likely in the second half of 2015. However, markets have interpreted the statement as more dovish, and the Canadian dollar and bond yields are down in the wake of the release.

• The Bank continues to highlight the current low level of inflation as a key downside risk. But, we expect that inflation has troughed in Canada, and is set to increase gradually over the next couple of years, helped by the recent depreciation in the Canadian dollar. A weaker loonie is inflationary on two fronts. It raises the price of imported goods, which filters through to many consumer purchases. And, it helps the competitive position of exporters, facilitating an export-led growth pick up in Canada. Stronger economic growth would also contribute to greater inflationary pressures in the economy going forward.