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Forward Guidance: Trade Deals Just One Factor in BoC’s Outlook

The Bank of Canada held interest rates steady throughout 2019 and is widely expected to do so again at its first meeting in 2020. While a run of soft economic data toward the end of last year suggests a rate cut isn’t out of the question, positive employment and business sentiment numbers in the past two weeks and a relatively neutral tone in Governor Poloz’s latest comments have markets and analysts convinced that a move won’t come in January. Based on the latest GDP figures, it would be reasonable to expect a dovish tone from Governing Council next week. Our current tracking points to growth having slowed to an annualized 0.7% pace in Q4/19, below the BoC’s already sub-trend 1.3% forecast. (Next week’s manufacturing and retail numbers, both expected to post increases for November, will help shape that call.) Transitory factors like labour disruptions weighed on activity, though a slowdown in job creation in H2/19 suggests the economy did in fact gear down over that period. We’re not expecting a significant rebound in growth early this year (pencilling in a 1.4% gain in Q1/20) and think persistently sub-trend growth leaves the door open to an eventual rate cut.

While a growth shortfall might suggest the economy is operating with a bit more slack than the BoC thought, its latest Business Outlook Survey indicated the economy is close to full employment outside of oil producing provinces. An improvement in overall business sentiment including positive indicators of future sales and an increase in hiring intentions should also help balance the central bank’s worries about slower growth. Concerns about household imbalances will also factor into the BoC’s upcoming rate decisions. Last week, Governor Poloz noted that demand for homes is outstripping supply (something that was fully evident in this week’s home sales data) which could prompt a return to extrapolative price expectations or “froth” in major markets. Financial stability issues associated with a resurgent housing market and rising mortgage debt, which raise the bar for a rate cut, have likely factored into the market’s reticence to price in much easing from the BoC this year (less than 50/50 odds of a move by December).

An improving external backdrop also reduces the urgency to lower rates. Given its focus on trade conflicts, the BoC was likely pleased with developments south of the border this week. Most significant was the signing of a phase-one trade deal between the US and China that represents a ceasefire in the two countries’ trade war—a spat that escalated throughout 2019 and contributed to a slowdown in global trade and industrial production. In exchange for modest relief from US import tariffs—and cancellation of threatened tariff hikes—China agreed to purchase an additional $200 billion of US goods over two years and undertake a number of reforms (e.g. address intellectual property theft, end forced technology transfer, refrain from currency manipulation). While a substantial increase in Chinese imports from the US (if the former follows through) has the potential to shape global trade flows, we think the most immediate impact of the phase-one deal is a reduction in trade uncertainty. Global business sentiment already showed signs of stabilizing in late-2019 as trade tensions and Brexit uncertainty eased, and a concrete US-China deal should add to that. (Indeed, the latest ISM manufacturing report explicitly said several industry sectors will improve as a result of the agreement.)

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Also this week, the US Senate approved the latest iteration of USMCA, leaving a signature from President Trump and passage through Canadian parliament the only remaining steps to ratification. In a recent speech, Governor Poloz said ratification “will remove one big source of uncertainty for many Canadian companies.” But ever-conscious of two-way risks around trade, he also noted concern that the EU might be the Trump administration’s next trade target.