Forward Guidance: BoC to Weigh Up Domestic Resilience, External Risks

Fundamental analysis of Forex market

We look for the Bank of Canada to strike a relatively neutral tone at next week’s meeting, deviating from policymakers at the US Fed and ECB that have turned increasingly dovish. Governing Council is likely to highlight signs of domestic resilience that offset growing trade risks and, for now, obviate the need to for a more accommodative policy stance—even with the Fed widely expected to lower rates.

Data since the BoC’s May 29 meeting have been plenty supportive. March and April GDP reports, on balance, showed a broadly-based pickup in economic activity following a winter slump. The energy sector is showing clear signs of recovery, and another key headwind—a slowdown in housing—is beginning to ease. We continue to track GDP growth of 2.2% in Q2, about 1 ppt above the BoC’s last forecast. The latest trade figures, which showed a surprising (and rare) surplus, suggest a decent contribution from net exports in the quarter. That might be difficult to sustain going forward—a number of one-offs helped boost exports in May, and the external environment is hardly supportive—but overall the BoC has plenty of evidence that the economy is recovering from its recent “detour”.

Inflation data should also keep the BoC from sounding too dovish. Headline inflation picked up to 2.4% in May and the BoC’s core measures ticked up to 2.1% on average, matching the fastest rate this cycle. Canada’s labour market remains in ship-shape notwithstanding a modest dip in hiring in June. And low unemployment is helping to push wage growth gradually higher, even if the current pace remains underwhelming.

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Balancing positive domestic data flow, the BoC is likely to note signs of slowing global growth and rising trade risks. On the former, the BoC’s forecast for global growth is already conservative and we don’t think they will materially revise those projections lower. On the latter, we’ve seen a further increase in Canada-China trade tensions but the bigger worry, a spat between the US and China, has changed very little since the bank’s last meeting. The BoC’s latest Business Outlook Survey showed surprising resilience in business sentiment even amid growing trade risks meaning Canadian firms aren’t panicking about global headwinds, and we think neither will the BoC.

Wednesday’s BoC meeting is likely to be overshadowed (even north of the border) by Fed Chair Powell’s Semi-annual Monetary Policy Report to the Congress (or “Humphrey Hawkins” testimony). If Powell is disinclined to lower rates in July, this would arguably be his best (and perhaps last) opportunity to push back against market pricing that overwhelmingly favours a 25 basis point cut (and even some odds of a 50 bp move). So unless he gives a clear signal that policymakers want to see more data before pre-emptively lowering rates, markets will continue to expect a July cut—making it difficult for the Fed to not follow through.

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