While the Bank of Canada left its key interest rate unchanged at 1%, its much more dovish statement got all the attention. Not only did the central bank signal that it isn’t thinking of hiking rates anytime soon, it appears to be in a holding pattern until 2013 as weaker external forces are affecting domestic confidence.
A change in language in the BoC’s statement diminishes the risk of near-term rate cuts. It replaced â€¦the need to withdraw monetary policy stimulus has diminished’ in the July statement with â€¦.there is considerable monetary policy stimulus in Canada’ in Tuesday’s statement.
That signals the BoC is content with its policy stance at the 1% overnight rate and remains very hesitant to risk returning toward the lower zero bound,’ said Derek Holt, economist at Scotia Capital.
The BoC also materially changed its inflation projection and now sees core inflation dipping below its 2% inflation target until the end of 2013. Meanwhile, headline inflation is expected to decline to 1% in 2012 before eventually returning to 2% by the end of 2013.
That is consistent with maintaining a rate hold throughout at least the next year and likely well into 2013,’ Mr. Holt said, adding that this would come close to mirroring the Fed’s mid-2013 loose commitment.
While the Bank of Canada believes there is no need to remove any monetary policy stimulus anytime soon and the global economy will improve in the second half of 2012, Capital Economics disagrees.
Instead, we still foresee a protracted period of economic weakness across most advanced economies, which will ultimately drag-down commodity prices and global inflation,’ said David Madani, the firm’s Canadian Economist.
As a result, he believes the BoC will eventually cut its key policy rate around the middle of next year, from 1.00% to 0.50%.
The first of two 25 basis point cuts is expected to come as soon as April, or maybe June, of 2012. Thereafter, Capital Economics expects rates on hold for a long time.
The BoC’s statement also represents a significant shift in stance from the already more dovish stance taken in September. This is highlighted by the central bank’s expectation that Europe is heading towards a brief’ recession.
The view on the U.S. is also less sanguine, not only relative to the last statement, but very importantly, relative to the July Monetary Policy Report (MPR) where the view was too optimistic,’ said Jimmy Jean, economic strategist at Desjardins Securities.
Combined with the weaker outlook and the integration of the recession risk for Europe, we see this as a more dovish stance but unless things were to deteriorate further (which they haven’t lately), the case for rate cuts will remain on the weak side, as opposed to a prolonged period of unchanged rates,’ he added.
Mr. Jean continues to expect the overnight rate to remain at 1% until 2013.
By reminding markets that Canada has a target rate near historic lows, a well-functioning financial system and considerable monetary policy stimulus, the BoC should quite any talk of the rate cuts markets had started to price in during the worst of the recent market turmoil.
They expect a resumption in rate hikes in the second half of 2012.