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Economic Risks Keep Interest Rates Steady

Dec 05, 2018

The Conference Board of Canada’s Principal Economist Alicia Macdonald offers the following insights on today's Bank of Canada announcement.

Quote

As expected, the Bank maintained its target for the overnight rate at 1.75 per cent this morning. With business investment faltering and more excess capacity than previously thought in the economy, we now expect that the Bank will not lift interest rates again until March.
—Alicia Macdonald, Principal Economist, The Conference Board of Canada.

Insights

  • After its 25-basis point increase in October, the Bank of Canada opted to hold its overnight rate steady in December but noted that interest rates will need to move to neutral to maintain inflation at target.
  • How fast interest rates move to their neutral rate will depend on how quickly the economy grows in relation to our potential, since it is the difference between actual and potential GDP that drives core inflation.
  • The latest readings on GDP are disappointing. Real GDP was down in September, indicating a weak start to fourth quarter growth while economic growth in the third quarter slowed.
  • While GDP growth in the quarter was roughly in line with the Bank’s recent forecast, looking beyond the headline numbers shows that the expected shift toward private investment and export-led growth faltered last quarter. Indeed, business investment tumbled and final domestic demand actually fell in the quarter. The 2.0 growth in GDP was primarily due to a sizeable drop in imports.
  • Looking forward, construction beginning on the large LNG Canada facility and new fiscal measures to stimulate investment will support growth. However, we also have cuts to oil production, the forthcoming closure of General Motor’s Oshawa plant, and the continuing adjustment of households to higher interest rates, which will all weigh on the economy.
  • Additionally, the latest revisions to GDP show that the economy has more excess capacity than previously thought, meaning GDP can grow above its potential without generating upward pressure on inflation.
  • Overall, we expect the economy will continue to grow at a moderate pace over the coming quarters. Moderate growth, combined with more excess capacity, means the Bank’s accommodative monetary policy will not need to be withdrawn as quickly as previously expected. Therefore, we now expect the Bank will remain on the sidelines in January, with its next rate increase in March.