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Forward Guidance: Central Bank Divergence Continues

Next week is a busy one. Both the Bank of Canada and US Federal Reserve will make policy announcements. Key GDP figures for Canada and the US are due, as well as jobs numbers for the latter. In politics, the EU is likely to extend next Thursday’s Brexit deadline by up to three months while PM Boris Johnson will once again push for a UK general election before year end. With Canada’s own election out of the way, we’ll be on the lookout for how the Liberals plan to prioritize their election promises and areas in which the minority government might find common ground with other parties. At this early stage, we expect higher budget deficits (in the mid-$20 billion range vs $14 billion last year) and modest fiscal stimulus targeted at households.

The Bank of Canada won’t incorporate new federal fiscal policy into its forecasts next week (it tends to wait until budget legislation is passed) but the prospect of a fiscal boost won’t be lost on Governing Council. That’s not the only reason the central bank is expected to hold interest rates steady on Wednesday. Canada’s economy continues to hold up well against global and domestic headwinds. We expect next week’s August GDP report will show only a modest increase, but that would be broadly consistent with the central bank’s view that growth is likely to be slower over the second half of the year. Job gains remain far more impressive (456,000 in the last twelve months) and low unemployment is finally delivering faster wage growth. Housing activity continues to pick up and lower market interest rates are providing some relief to debt-laden households, even if retail sales growth remains modest. The energy sector continues to struggle but weakness in manufacturing has been less than feared given the slowdown in industrial production globally. Meanwhile, the services sector (70% of the economy) is humming along and business confidence hasn’t softened as much in Canada as it has abroad. The economy is operating close to full capacity, with underlying inflation close to 2% and businesses citing rising capacity pressures in most regions. That should leave the BoC with the view that Canada’s economy is in a good place despite concerns about the global backdrop.

A steady rate decision and likely neutral tone from the BoC will stand in contrast with a third consecutive rate cut from the Fed. Recall that the FOMC was split on the need for further easing following September’s meeting. With softer business sentiment continuing to generate fears of a downturn, we’d be surprised if the Fed shocked markets by leaving rates unchanged. A third rate cut would be in keeping with past mid-cycle adjustments (1995 and 1998 are the most recent examples) that saw 75 basis points of easing. The Fed has framed these rate cuts as insurance against slowing global growth and trade policy headwinds that have hurt the US industrial sector and business investment. Early progress toward de-escalating US-China trade tensions, and diminished odds of a no-deal Brexit, should leave the Fed comfortable holding rates steady after next week’s cut. Next Friday’s payroll report is likely to be soft due to the GM strike (we expect an 85k gain in October vs. 161k year-to-date) but that should be unwound in November.

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