BOC Removes “Cautious” Reference, But 2H17 Rate Hikes Experience Suggests Members Can Make Over-Aggressive Judgements

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Canadian dollar recorded the biggest one-day rally in two months after BOC’s more hawkish- than- expected statement. Policymakers turned less concerned over the economic outlook. As such, they dropped the words “cautious” and “over time” in the accompanying statement, a sign interpreted by the market as supportive for a rate hike in the near-term. Bets of a rate July rate hike jumped to 65% after the announcement, from less than 50% before that. In our opinion, it might be premature to associate removal of “cautious” at the May meeting to “rate hike coming soon”. Intermeeting dataflow should be the key.

In the concluding statement, BOC suggested that “developments since April further reinforce Governing Council’s view that higher interest rates will be warranted to keep inflation near target”. With the reference, “over time”, dropped, the market expects a rate hike would come soon. Meanwhile, the central bank reiterated that it would “take a gradual approach to policy adjustments, guided by incoming data” and it would “continue to assess the economy’s sensitivity to interest rate movements and the evolution of economic capacity”. However, it removed the reference that the members would “remain cautious with respect to future policy adjustments, guided by incoming data”. This is interpreted as a hawkish shift.

Supporting BOC’s confidence are recent economic developments both in Canada and in the US. At home, inflation would “likely be a bit higher in the near term than forecast in April” as driven by “increases in gasoline prices”. The central bank stressed that it would “look through the transitory impact of fluctuations in gasoline prices”. Moreover, the members acknowledged that “activity in the first quarter appears to have been a little stronger than projected”. They forecast that “solid labour income growth supports the expectation that housing activity will pick up and consumption will continue to contribute importantly to growth in 2018”.

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BOC remains confident over US’ outlook, noting that “recent data point to some upside to the outlook for the US economy”. Yet, they also reminded that “ongoing uncertainty about trade policies is dampening global business investment and stresses are developing in some emerging market economies. Global oil prices have been higher than assumed in April, in part reflecting geopolitical developments”.

The overall tone of the statement is more confident than the April one. Note, however, that BOC has no track record of offering “forward guidance” when compared with the Fed. On the contrary, the central bank has a “black mark” of making U-turn after over aggressive tightening. Back in October 2017, BOC expressed genuine concerns over the downside risks to inflation and indicated it would be more “cautious” over future rate hike decisions. In the accompanying statement, it stressed that “while less monetary policy stimulus will likely be required over time, Governing Council will be cautious in making future adjustments to the policy rate”. The abrupt change in the tone was after an unexpected rate in September, following the one in July. The negative impacts of the July rate hike: July GDP stagnating after growing for 8 months in a row, retail sales surprisingly contracting in August, etc. Yet, BOC incurred another rate hike in September before these reports were released. It might be premature to associate removal of “cautious” at the May meeting to “rate hike coming soon”. Dataflow and US trade policy should be closely monitored in the 6-week period from now to the July meeting.

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