Bank of Canada said to deliver a rate hike but risks hang – Forex News Preview
January 16, 2018 5:26 pm
Just two weeks after the start of the new year, the Bank of Canada will be the first in line to decide on monetary policy and as forecasts suggest the central bank will likely go with another rate hike. Some could say, though, that now is not the best time for Canada to welcome higher rates given the complicated situation of the NAFTA talks and the country’s overloaded household debt. But this is not the big question. Instead, investors wonder whether the BOC will be in rush to catch up with its US counterparts who are currently ahead in terms of stimulus reduction.
Last year the BOC raised interest rates twice by 0.25 basis points each time (July, September), sending the overnight lending rate to 1.0%. Rising oil prices, better than expected GDP growth readings and a falling unemployment rate, which slipped to the lowest level seen in over 40 years, where among the factors to persuade policymakers to cut some stimulus. Besides that, Canadians are currently heavily indebted and hold the largest debt bulk relative to their G7 counterparts, with the country’s household-debt-to-GDP peaking at a fresh record high of 171.1% in the third quarter of 2017. This fact was and could be a good reasoning for central bankers to increase rates in order to limit credit growth.
Now for Wednesday, the BOC will gather again around the table to decide on monetary policy with the announcement expected to be made at 1500 GMT. Analysts believe that policymakers will deliver further monetary tightening, with the markets highly pricing in (91% probability) a 25 basis points increase that will drive interest rates to 1.25% even if inflation remains far below the BOC’s target of 2.0%. From the BOC side, a buoyant labor market which is seen operating near full employment conditions is expected to exert upward pressure on wage growth as long as “productivity growth remains strong” and therefore push price inflation towards 2.0% by 2019. Recent comments by the BOC Governor, Stephen Poloz also add to the odds of a stimulus removal after Poloz claimed that the BOC “approach to monetary policy has become particularly data dependent because of significant unknowns around the inflation outlook”.
Still, risks are hanging around the NAFTA story, which has made little progress in its already fifth round of talks, and any negative developments including the scenario of the US president terminating the trade deal could ruin the central bank’s plans to keep raising borrowing costs given that Canada sends over three quarters of its exports to the US. However, this also implies that Canadian exports could become attractive elsewhere if the loonie turns cheaper on the news.
The debt issue, though, seems to hold the BOC’s hands tight not only because higher interest rates would further limit households’ finances but because this would restrict the BOC to keep pace with the Fed rates. Unlike Canada, the US is in a better position in terms of debt levels, therefore, the Fed has one less reason to worry about when considering increasing rates which are projected to rise three times this year. The markets also see three rate increases for Canada the end of the year but with consumers struggling to meet their loan obligations given the new stricter mortgage regulations valid as of January 1, 2018, the pace of increases could lose steam and lag those in the US.
In forex markets, the loonie could gain further momentum if the BOC indeed decides to roll back stimulus, driving dollar/loonie down to the 1.23 and 1.22 key areas, while a bullish longer-term outlook for the loonie would only emerge below the 1.21 handle.
In the alternative scenario, a dovish monetary statement would be positive for the dollar, leading dollar/loonie up to the previous top at 1.2589. Steeper increases could also target the 1.2700 handle, opening the scope for a retest of the six-month high of 1.2931.
Just two weeks after the start of the new year, the Bank of Canada will be the first in line to decide on monetary policy and as forecasts suggest the central bank will likely go with another rate hike. Some could say, though, that now is not the best time for Canada to welcome higher rates given the complicated situation of the NAFTA talks and the country’s overloaded household debt. But this is not the big question. Instead, investors wonder whether the BOC will be in rush to catch up with its US counterparts who are currently ahead in terms of stimulus reduction.
Last year the BOC raised interest rates twice by 0.25 basis points each time (July, September), sending the overnight lending rate to 1.0%. Rising oil prices, better than expected GDP growth readings and a falling unemployment rate, which slipped to the lowest level seen in over 40 years, where among the factors to persuade policymakers to cut some stimulus. Besides that, Canadians are currently heavily indebted and hold the largest debt bulk relative to their G7 counterparts, with the country’s household-debt-to-GDP peaking at a fresh record high of 171.1% in the third quarter of 2017. This fact was and could be a good reasoning for central bankers to increase rates in order to limit credit growth.
Now for Wednesday, the BOC will gather again around the table to decide on monetary policy with the announcement expected to be made at 1500 GMT. Analysts believe that policymakers will deliver further monetary tightening, with the markets highly pricing in (91% probability) a 25 basis points increase that will drive interest rates to 1.25% even if inflation remains far below the BOC’s target of 2.0%. From the BOC side, a buoyant labor market which is seen operating near full employment conditions is expected to exert upward pressure on wage growth as long as “productivity growth remains strong” and therefore push price inflation towards 2.0% by 2019. Recent comments by the BOC Governor, Stephen Poloz also add to the odds of a stimulus removal after Poloz claimed that the BOC “approach to monetary policy has become particularly data dependent because of significant unknowns around the inflation outlook”.
Still, risks are hanging around the NAFTA story, which has made little progress in its already fifth round of talks, and any negative developments including the scenario of the US president terminating the trade deal could ruin the central bank’s plans to keep raising borrowing costs given that Canada sends over three quarters of its exports to the US. However, this also implies that Canadian exports could become attractive elsewhere if the loonie turns cheaper on the news.
The debt issue, though, seems to hold the BOC’s hands tight not only because higher interest rates would further limit households’ finances but because this would restrict the BOC to keep pace with the Fed rates. Unlike Canada, the US is in a better position in terms of debt levels, therefore, the Fed has one less reason to worry about when considering increasing rates which are projected to rise three times this year. The markets also see three rate increases for Canada the end of the year but with consumers struggling to meet their loan obligations given the new stricter mortgage regulations valid as of January 1, 2018, the pace of increases could lose steam and lag those in the US.
In forex markets, the loonie could gain further momentum if the BOC indeed decides to roll back stimulus, driving dollar/loonie down to the 1.23 and 1.22 key areas, while a bullish longer-term outlook for the loonie would only emerge below the 1.21 handle.
In the alternative scenario, a dovish monetary statement would be positive for the dollar, leading dollar/loonie up to the previous top at 1.2589. Steeper increases could also target the 1.2700 handle, opening the scope for a retest of the six-month high of 1.2931.
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