The central bank’s tone, however, was more dovish than many economists were expecting.
So where do rates go from here? Canada’s top economists weigh in:
Avery Shenfeld, CIBC chief economist
• One further hike this year, early in Q3, and a further 50 bps in 2019
“Today’s rate hike was a rear-view mirror move, but the Bank of Canada hints that the view out the front window isn’t quite as sunny. Canada did so well in 2017 that it left little slack in labour markets or capacity in its wake, easily justifying a quarter-point hike today. The output gap is now slightly positive, so quarterly growth rates from here have to average below 2 per cent (the Bank has 1.8 per cent for the average of the next four quarters) to avoid an inflationary overheating. We share the Bank of Canada’s view that higher rates will be needed over time to stay on that path, but they won’t come quite as fast and furious as the market was starting to think. For one, the Bank’s statement put NAFTA uncertainties right up front, and has started to build in a drag on investment and exports into its forecast.
While the Bank isn’t ready to assume that NAFTA will be completely cancelled, doubts on that front can impact business sentiment, and they’ve included a 0.5% hit to the level of GDP through the next two years to account for that effect.
… Overall, this was a dovish statement relative to the minimum degree of optimism needed to justify a rate hike today, and could put some downward pressure on 2-year yields and the value of the C$. We’re looking for one further hike this year, likely early in Q3, and a further 50 bps in 2019. Yes, we’re facing higher rates, but not SO fast given other risks to growth ahead.
Mark Chandler, RBC Dominion Securities, head of Canadian rates strategy
• Three more hikes to leave the overnight target at 2% by the end of 2018
Overall, the “cautious” catchword from the BoC remains in place even with today’s hike and this may be how additional moves later this year pan out (we expect three more to leave the overnight target at 2.00% by the end of 2018). We concur with the Bank’s assessment that “some accommodation will likely be needed to keep the economy operating close to potential and inflation on target” and we believe that the Bank will need to slow the pace of rate hikes in 2019 (we currently have the overnight rate holding at 2.25%, below the 3.00% mid-point of the Bank’s estimated neutral rate range, largely reflecting the impact of higher rates on high household debt).
Douglas Porter, BMO chief economist
• Sticking with prior call of two more hikes in 2018, ending the year at 1.75 per cent, but next hike not until July
While the move was no big surprise (markets had assumed a greater-than-80% chance of a rate hike), the initial read on the commentary leaned a tad dovish, with the Bank re-stating that they would be “cautious” in future rate moves, putting the NAFTA risk front and centre, and suggesting that “some continued monetary policy accommodation will likely be needed”. Having said that, the dovish remarks did not run the table, as they nudged up their growth forecasts for the next two years, and actually sounded a bit positive on non-auto exports … By making NAFTA risks so prominent in this Statement, rate hike odds will now ebb and flow with the negotiations, even moreso than earlier.One new possibility is that the talks could be put on ice for a spell until after the mid-year Mexican election; if that’s how it indeed plays out, then the Bank could get on with its business sooner. Bottom Line: Combined with lingering uncertainties around NAFTA and the housing market, we suspect the Bank will take a bit more time before hiking again. Barring another run of roaring data, we look for the Bank to hold off until possibly July before hiking again (depending, of course, on the fate of the NAFTA talks). But, big picture view, we remain entirely comfortable with our prior call that the Bank will hike two more times in 2018, ending the year at 1.75%.
David Madani, senior Canadian economist, Capital Economics
• Hike in spring, probably April, followed by a rate cut before year-end
The Bank of Canada’s … more upbeat economic outlook suggests that it will hike rates again later this year, probably in April. In contrast to the consensus, we wouldn’t bet too heavily on further rates hikes beyond the spring, however. The economy is still heavily dependent on housing and debt which, we still firmly believe, will eventually upend the economy and prompt a reversal in monetary policy before year-end.
Brian DePratto, TD Economics senior economist
• Gradual pace of tightening is most likely, with the next hike penciled in for July
Emergency level rates may not be needed, but that doesn’t mean that the Bank is in a rush to continue hiking. NAFTA uncertainty hangs over the outlook, with the Bank explicitly downgrading the outlook for business investment and trade to account for the impact of negotiations. What’s more, despite the positive run of labour market data, wage growth remains weaker than the Bank had expected. Most explicit was the statement that while the outlook will likely “warrant higher interest rates over time, some continued monetary policy accommodation will likely be needed”.
As such, it remains our base-case view that a gradual pace of tightening is most likely, with the next hike penciled in for July. Data dependency of course means that this is not a lock. Developments in Poloz’s list of areas to watch, including interest rate sensitivity, labour market developments, and inflation dynamics could easily bring the next hike forward, or push it back.
The Bank of Canada had a window to raise interest rates and it opted to use it.
Canada’s central bank raised its lending benchmark a quarter point to 1.25 per cent, an historically low setting that nonetheless will seem high to anyone who got used to post-crisis borrowing costs that were closer to zero.
“Recent data have been strong, inflation is close to target, and the economy is operating roughly at capacity,” the Bank of Canada said in a statement summarizing its latest round of policy deliberations.
Governor Stephen Poloz wasn’t dying to make money more expensive.
In mid-December, Poloz emphasized that he thought lower borrowing costs could pull more people into the labour market and reverse an extended period of stagnant wage gains. The central bank also said it was wary of U.S. President Donald Trump’s threats to quit the North American Free Trade Agreement and how investors and executives would respond to the regular exchange of threats between the United States and North Korea.
Those factors mean Poloz and his advisers on the Governing Council have set a high bar for interest-rate increases in the near term. To emphasize that point, the central bank followed its positive assessment of the economy with a reminder of its worries about NAFTA, the future of which is “clouding the economic outlook,” policy makers said.
Still, the central bank said last year that interest rates must eventually return to higher levels to keep inflation from running out of control, and that it would lift borrowing costs when data send a clear signal. That standard had been met by the end of December, when the unemployment rate dropped to the lowest level in at least four decades.
“Recent data show that that labour market slack is being absorbed more quickly than anticipated,” the Bank of Canada said.
A recent survey of businesses also showed that executives intend to increase investment over the year ahead, despite uncertainty over trade and stability of the international order. Yet policy makers sense fragility in that sentiment. They said worries over the NAFTA are starting to paralyze decision making, and causing some money that might have been spent in Canada to end up in the United States. As a result, the central bank increased its estimate of how much economic growth will be hurt by trade uncertainty. (The central bank predicts gross domestic product will slow to 2.2 per cent in 2018 and 1.6 per cent in 2019, after expanding 3 per cent last year.)
President Donald Trump’s business tax cuts at the end of 2017 will give companies and investors another reason to choose the U.S. over Canada. The central bank assumes only a “small” benefit for Canada from the tax changes because any increase to demand for exports will be nearly offset by lost investment.
“Underlying fundamentals are strong and would support a more robust growth trajectory were it not for the effects of heightened uncertainty around trade policy and increased incentives to shift investment from Canada to the United States as a result to U.S. tax reforms,” the central bank said its latest quarterly report on the economy.
The closest observers of Canadian monetary policy saw the shift coming, albeit some sooner than others.
By last week, the chief economists at all seven of the country’s biggest were predicting a quarter-point increase. The C.D. Howe Institute’s Monetary Policy Council, a panel of academics and Bay Street analysts, said on Jan. 11 that the central bank should raise interests rates by a quarter point today, and at least twice more before the end of the year. That was a shift. At the end of November, the informal group said the Bank of Canada should wait until the spring of 2018 to raise interest rates, and then add a second quarter-point increase by the end of the year.
Predicting the next increase will be more difficult.
Some forecasters, including economists at Royal Bank of Canada, see three more quarter-point increases this year. That seems aggressive, given the Bank of Canada’s doubts about the ability of Canadian companies to compete with Trump’s America in the short term. Those concerns argue for lower interest rates, at least until the future of NAFTA is resolved.
The global economy continues to strengthen, with growth expected to average 3 1/2 per cent over the projection horizon. Growth in advanced economies is projected to be stronger than in the Bank’s October Monetary Policy Report (MPR). In particular, there are signs of increasing momentum in the US economy, which will be boosted further by recent tax changes. Global commodity prices are higher, although the benefits to Canada are being diluted by wider spreads between benchmark world and Canadian oil prices.
In Canada, real GDP growth is expected to slow to 2.2 per cent in 2018 and 1.6 per cent in 2019, following an estimated 3.0 per cent in 2017. Growth is expected to remain above potential through the first quarter of 2018 and then slow to a rate close to potential for the rest of the projection horizon.
Consumption and residential investment have been stronger than anticipated, reflecting strong employment growth. Business investment has been increasing at a solid pace, and investment intentions remain positive. Exports have been weaker than expected although, apart from cross-border shifts in automotive production, there have been positive signs in most other categories.
Looking forward, consumption and residential investment are expected to contribute less to growth, given higher interest rates and new mortgage guidelines, while business investment and exports are expected to contribute more. The Bank’s outlook takes into account a small benefit to Canada’s economy from stronger US demand arising from recent tax changes. However, as uncertainty about the future of NAFTA is weighing increasingly on the outlook, the Bank has incorporated into its projection additional negative judgement on business investment and trade.
The Bank continues to monitor the extent to which strong demand is boosting potential, creating room for more non-inflationary expansion. In this respect, capital investment, firm creation, labour force participation, and hours worked are all showing promising signs. Recent data show that labour market slack is being absorbed more quickly than anticipated. Wages have picked up but are rising by less than would be typical in the absence of labour market slack.
In this context, inflation is close to 2 per cent and core measures of inflation have edged up, consistent with diminishing slack in the economy. The Bank expects CPI inflation to fluctuate in the months ahead as various temporary factors (including gasoline and electricity prices) unwind. Looking through these temporary factors, inflation is expected to remain close to 2 per cent over the projection horizon.
While the economic outlook is expected to warrant higher interest rates over time, some continued monetary policy accommodation will likely be needed to keep the economy operating close to potential and inflation on target. Governing Council will remain cautious in considering future policy adjustments, guided by incoming data in assessing the economy’s sensitivity to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation.
OTTAWA — All eyes will be on the Bank of Canada this morning as it makes its latest scheduled interest-rate announcement.
Economists widely believe that based on the economic environment, it’s likely that governor Stephen Poloz will raise the central bank’s benchmark interest rate today for a third time since last summer.
Market odds of a rate hike are now close to 90 per cent.
Many note that Poloz has indicated that interest rate decisions will be data dependent.
In addition to a stronger-than-expected jobs report released earlier this month, the central bank’s Business Outlook Survey revealed that sentiment remained positive during the final quarter of 2017.
But many economists say a rate hike today doesn’t mean the Bank of Canada is poised to start a rapid tightening cycle.
Given high household debt levels, the unknown impact of tighter stress tests for uninsured mortgages that came into effect this year and uncertainty surrounding NAFTA renegotiations, the bank must be cautious about how quickly it raises rates in order to avoid derailing the economy.
Scotiabank Economics is forecasting 75 basis points of gradual tightening this year spread out throughout 2018, while TD Economics expects a gradual pace of tightening over the next two years of about 25 basis points every six months.
RBC Economics Research says it expects the Bank of Canada to raise the overnight rate by 25 basis points to 1.25 per cent today.
OTTAWA — Higher oil prices and a roaring economy are expected to spur a rise in business investment in 2018, several prominent economists said Tuesday, as Canada continues to shrug off any indication that it is headed for a substantial slowdown this year.
Business investment levels in Canada have remained positive in recent years, despite a collapse in oil prices in 2014 that caused widespread retrenchment in the oil and gas sector. But now, with prices for West Texas Intermediate trading well above the US$60 threshold, economy-wide investment is expected to grow back to pre-recessionary levels.
“It’s the start of a bounce back,” said Brian DePratto, a senior economist at TD Bank. “This is not necessarily surprising after two years of negative investment, but it seems we’ve come off that bottom after, in 2017, seeing very, very healthy investment numbers.”
Depratto said other lesser-known sectors, like food manufacturing, have also begun to unexpectedly raise investment levels.
“Business investment has been surprisingly strong,” said Jean-François Perrault, the senior vice-president and chief economist at Scotiabank, whose comments came during panel discussion Tuesday hosted by the Canadian Club of Ottawa.
Projections of higher investment were supported by a report from the Business Development Bank of Canada on Tuesday that expects small- and medium-size companies to invest $140.5 billion in 2018, a three per cent bump the year prior. That figure includes an estimated 79 per cent increase on acquisitions over the year.
Investment in B.C. is expected to lead the country at 17 per cent higher, followed by Alberta (12 per cent) and Quebec (11 per cent). Ontario is expected to see a one per cent decrease in investment, while other provinces could see larger drops.
Higher business investment estimates could be seen as a further indication that the Bank of Canada should raise its overnight interest rate Wednesday. Analysts are in near-unanimous consensus in expecting the BoC to raise rates, particularly after recent data showed a major tightening in the Canadian labour market.
Many analysts have for some time been projecting the Canadian economy to take a steep dive after posting quarterly growth rates last year that were well above four per cent. However, the economy has increasingly outpaced growth expectations.
“We worry a lot about the downside risks,” Perrault said. “But I think we are still potentially underestimating the upsides.”
Business investment, high household debts and still-low wage growth were some of the main concerns that caused the BoC to hold off on further rate hikes last year.
Dawn Desjardins, the vice-president and deputy chief economist at RBC, said she expects business investment to grow over the next 12 months, despite repeated concerns that deep tax cuts in the U.S. could make Canadian businesses less competitive with their counterparts.
“We have a lot of costs to run businesses today,” said “Whether it’s carbon pricing or all these other costs that are rising for businesses — at the same time I do think demand is there, and businesses will continue to this pick up in investment as we go forward.”
The three panellists also saw investment growing despite concerns over negotiations of the North American Free Trade Agreement, which have seemed increasingly likely to fail in recent weeks following media reports.
The analysts generally see the BoC consecutively raising rates in 2018 by about one per cent, and expect inflation to near the bank’s two per cent target range.
Foreign-exchange traders who had all but priced in a Bank of Canada rate hike are suddenly paying up to hedge against the risk of a letdown at Wednesday’s policy meeting.
The country’s five biggest lenders all brought forward their rate-hike expectations to January from April this month after the nation’s jobless rate dropped to its lowest in more than 40 years. But the cost to protect against loonie losses has skyrocketed after reports the U.S. would withdraw from the North American Free Trade Agreement gave investors pause and thrust the prospect of a stand-pat BoC into the spotlight.
Implied volatility contracts with a tenor of one week spiked to 10.6 intraday Tuesday, the highest since the days surrounding the central bank’s September gathering, when officials shocked markets with their second hike in as many meetings. The loonie fell as much as about 0.95 per cent Jan. 10, the most in more than two months, the day the NAFTA speculation swirled. The Canadian currency has gained about 6 per cent versus the U.S. dollar in the past 12 months, and the pair currently trades around $1.2430.
The market-implied odds that the BoC raises rates this week still stand at about 92 per cent, based on overnight index swap pricing. They fell to as low as 73 per cent last week after Canadian officials said they saw an increasing likelihood that U.S. President Donald Trump would withdraw from NAFTA. Twenty-six of 27 economists surveyed by Bloomberg forecast the central bank will raise its benchmark rate 25 basis points to 1.25 per cent.
“There are more two-way risks around the hike than the bond market is pricing in,” said Mark McCormick, a strategist at TD Securities, which pushed forward its rate-increase call to January. McCormick said he puts the odds of a rate boost this week around 65 per cent.
Even if the BoC did hike, it probably wouldn’t do much to help the Canadian dollar since NAFTA talks resume next week and there’s more at stake in the next round of negotiations, McCormick said.
If the Bank of Canada does raise rates Wednesday, it could signal that further increases are unlikely to be aggressive, a so-called “dovish” hike, in an effort to extend the economy’s stellar 2017 performance. And if it leaves rates unchanged, the bank could still offer a resolute tone on gradual tightening as policy makers must now be wary of stoking inflation.
“In the event that we do get a hike, it would be a dovish hike,” said Eric Theoret, a currency strategist at Scotiabank. “In the event we get a hold, it would be a hawkish hold because in the event of a hold, I don’t think it’s an environment in which they’d want to ease financial conditions. That’s the outcome I would lean toward, a hawkish hold.”
Scotiabank’s house view is for a rate increase Wednesday, though Theoret says “the hawkish hold is underappreciated as an outcome.”
Following the report on Canadian officials’ concerns about NAFTA negotiations, a White House official said there hasn’t been any change in the president’s position on the agreement. U.S. Treasury Secretary Steven Mnuchin said Jan. 11 he expects the pact “will be renegotiated, or we’ll pull out.”
The sixth round of NAFTA talks is scheduled to start Jan. 23 in Montreal. Canada, Mexico and the U.S. have already planned a subsequent round of talks in February in Mexico City, two people familiar with plans said.
Small to medium-sized enterprises (SMEs) in Canada are showing a renewed confidence in their future prospects, according to the Business Development of Canada’s (BDC) newly released study, Investment Intentions of Canadian Entrepreneurs: An Outlook for 2018.
The cross-Canada report reveals that business optimism is at its highest point of the past three years. Overall, the upswing is attributable to business acquisition and growth plans, with SMEs planning to make $140.5 billion in investments this year – a three-per-cent increase over 2017.
“This is a strong indication we are going to have a good year for the Canadian economy in 2018,” says Pierre Cléroux, vice-president research and chief economist at BDC. “What is particularly surprising is that the biggest increase is in business acquisition plans. We have not seen that before.”
According to the study, acquisition plans have increased by 79 per cent over the past year ($18.9 billion, up from $10.6 billion in 2017). “That’s a huge difference on where SMEs are going to focus their investment,” Cléroux says. “But this is not unique to Canada. It is happening globally. In Germany for example, there are 500,000 businesses for sale.”
The acquisition focus is attributable to the fact there are a growing number of entrepreneurs reaching retirement age and ready to sell their businesses, Cléroux says. “Many probably waited to sell because the economy wasn’t strong. Now if you’re 60 or 65 and thinking of retiring, it’s a pretty good time to do it, and a great time for young entrepreneurs to make a move and expand.”
Other highlights of the study include:
— Sustaining growth was the top-cited reason for investing in 2018, followed by boosting the value of the business and keeping pace with the competition.
— Technology and services businesses showed the highest growth in investment intentions at eight and seven per cent respectively, while manufacturing is flat, and construction and resources industries are expected to decline.
— The highest investment increases are in British Columbia and the territories (17 per cent), Alberta (12 per cent) and Quebec (11 per cent).
— Ontario businesses expect to trim investments by one per cent in 2018 and other regions expect to have steeper drops.
Another trend of note is that investment is increasingly focused on intangible assets versus equipment and buildings. The study indicates that spending on R&D and employee training will rise by $2.4 billion this year, reflecting a long-term shift in the way Canadian businesses invest. “This is a phenomenon that has gained ground over the last four years,” Cléroux, says. “It will be interesting to watch as there will be more and more need for financing based on intangible assets. Financial institutions will have to adjust to this new reality.”
In looking at obstacles to growth, shortage of skilled workers topped the list in most provinces, with chronic labour shortages especially pronounced in rural Quebec and Nova Scotia. “In exploring further, we found in some cases, they could not find anybody,” Cléroux says. “In others it was working with what they can find. Businesses are spending more money now on hiring people that may not be the right fit, and helping them to gain the right experience and skills. That’s another trend we have not seen in the past.”
In terms of variables that may influence business investment decisions in 2018, Cléroux cites interest rates, NAFTA and labour. “Interest rates are going to increase in Canada and the U.S. The Canadian economy is running at full capacity, and unemployment at 5.7 per cent, which is very low. We expect to see (rate) increases that will have an impact on businesses and consumers.”
NAFTA negotiations continue to create uncertainty for businesses, he adds. “I have not met a single business owner that knows what their tariff would be if NAFTA does not go through. They are not well prepared about an end to NAFTA. Even if there is no free trade agreement, however, I don’t believe it will have a major impact.”
On the labour front, Cléroux believes enterprises have underestimated the drastic changes taking place. “The labour force is not increasing anymore and will not for the next few years. It will get much more difficult to hire people. Baby Boomers will be gone, and millennials are taking over with different expectations.”
With the massive retirement numbers, businesses will need more people from the outside, he adds. “Eighty per cent of growth in the labour force will come from outside of Canada over the next decade. Businesses will have to be more open-minded and think differently about how they manage human resources in the future.”
BDC’s third annual study of SME investment intentions is based on a survey conducted last August and September by the research firm SOM with 4,019 business owners.