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Forward Guidance: Coronavirus Risks in Focus with BoC Set to Cut Rates

Backward looking economic indicators – including US and Canadian employment reports for January over the next week – will probably continue to take a firm backseat to concerns about the spread of COVID-19 more significantly beyond China’s borders. Economic forecasts, including our own, broadly continue to expect the impact of that disease on economic growth numbers to be temporary – notwithstanding the obvious human cost for those infected. And reported improvement in China, with the government encouraging people to return to work in less-impacted areas, means current near-term supply chain risks for Canada have not obviously increased at this point despite the wider spread outside of China’s borders. But the risk of a larger economic impact should the spread of the virus accelerate further is not insignificant. Financial markets are clearly concerned that disruptions could be larger and longer-lived given the 30 basis point drop in US 10-year bond yields, and 10%-plus sell-off in stocks, over the last week alone.

Central banks are increasingly expected to respond with lower interest rates. Markets are now expecting almost 100 bps of cuts from the US fed by this time next year. We now expect the Bank of Canada to cut rates at their next scheduled policy decision on March 4th in response to the ongoing financial market meltdown with markets pricing in an even more aggressive move this year than the two total cuts we now expect. To be sure, the negative economic fallout from the coronavirus in North America has yet to become apparent in hard economic data. But, for Canada, lower oil prices are already reducing economy-wide export revenue and the risk of the virus having a similar, even if still temporary, disruptive impact in other economies if it spreads too significantly will give central banks cover (if they felt any were needed given the pullback in financial markets) to cut rates pre-emptively.

Against that backdrop, actual economic data will have much less significance to central banks, including the Bank of Canada, until reports start to come in for time-periods more directly susceptible to an impact from the outbreaks. Canada and US employment numbers for February next week probably won’t qualify – the survey periods for both were earlier in the month. Neither will the Canadian January international trade report. Certainly trade flows with China in January will be watched closely, but it will be difficult to parse how much of any near-term disruption might be due to the coronavirus outbreak versus the earlier-than-usual Chinese New Year holiday period this year. For what it’s worth, even with slower economic growth in Canada in Q4, the economy broadly does not appear to be in bad shape. Wage growth is still running 3% or higher. Inflation is locked right around 2%, if not a little higher. Consumer confidence actually increased in February (one of the few data points outside of financial markets for the period over which coronavirus concerns might have been expected to make more of an appearance) and business confidence also appeared to improve a bit according to the Canadian Federation of Independent Business. We expect next week’s Canadian labour market report to show a small increase in jobs alongside a tick up in the unemployment rate but driven by higher labour force participation. Any upside surprise in the normally volatile employment numbers will probably be discounted by forward-looking coronavirus concerns, while any downside surprise will only reinforce expectations for the BoC to continue to ease policy.

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