Bank of Canada holds rates steady amid economy’s “uneven” adjustment

May 25, 2016

The Bank of Canada held the overnight rate steady at 0.50% as expected. The brief policy statement acknowledged a number of developments since the April 2016 meeting; the sum of which indicated that the economy’s adjustment to lower oil prices is continuing although “proving to be uneven.” The Bank made a nod to weak business investment and intentions, but there was no mention of the recent softness in exports. Global growth is evolving largely as expected, with the US economy expected to rebound after a slow start to the year, which suggests to us that the Bank remains comfortable with its forecast for exports to pick up this year and next.

The statement noted that second-quarter 2016 growth will be negatively affected by the Alberta wildfires, with the Bank’s preliminary assessment indicating fire-related destruction and oil production shutdowns will shave 1.25 percentage points off gross domestic product (GDP) growth in the quarter. Our current monitoring assumes that a slightly larger hit (1.5 percentage points) will leave growth close to flat in the second quarter, and like the Bank, we expect a rebound in the third quarter as production resumes and reconstruction begins.

The Bank sounded slightly more concerned about financial stability risks, noting that household vulnerabilities “have moved higher,” with Canada’s housing market showing strong regional divergence; however, with risks to the inflation outlook remaining roughly balanced, the current stance of monetary policy was once again deemed appropriate.

The Bank of Canada has kept an even keel through a choppy start to 2016—not becoming overly excited when the data showed strong, export-led growth early this year and, today, not sounding too pessimistic following a string of disappointing reports. The Bank’s “rotation” narrative has taken a hit, with non-energy exports now flat year over year and investment intentions pointing to weak private-sector capital spending this year (particularly in the manufacturing sector), but the Bank always expected that the shift toward stronger growth in the non-resource economy would be gradual and, as emphasized today, “uneven”. The Bank’s policy statement was not explicit about changes to its forecast for average growth of 2% during the first three quarters of 2016, although that pattern has shifted due to the transitory effect of the Alberta wildfires. Looking through near-term volatility, there is little to suggest that the economy will reach full capacity later than expected, which should keep the Bank on the sidelines this year; however, with the path likely to remain gradual and uneven, a cautious tone should prevail in the near term.

Josh Nye, Economist, RBC Economics