Bank of Canada Likely to Keep Rates Unchanged Until 2016

The Bank of Canada bolstered expectations for no change in rates well into next year as they maintained the outlook that full capacity would return by the end of 2016. The Governor expressed satisfaction that the January rate cut had delivered the economy to its current state, where the oil drag is having a substantially faster but not more pronounced effect than was expected in January. While economic data will need to confirm that the magnitude of the oil drag did not outpace projections in Q1, a realization of the Bank’s growth and inflation outlook would keep policy steady well into 2016.

The April outlook revealed a different growth path than in January, but one that arrives at the same destination by the end of 2016. That place if of course the long awaited condition of full capacity growth, which will be reached once the economy gradually uses up current considerable slack.

The path to the end of 2016 is different than was envisioned by the Bank of Canada in January. The key change to the projection was that Q1 GDP is now seen as flat compared to +1.5%, while Q2 was nudged higher to 1.8% from +1.5%. By the middle of the year, growth in export industries with close ties to the U.S. that benefit from a weaker Canadian dollar should more than offset any faded oil price drag, leaving GDP growth running near 2.5% for the second half and in 2016.

Overall, the Bank of Canada is clearly comfortable with the current policy setting, as the record low 0.75% policy rate allows the economy to ride-out the oil shock. As the oil shock fades, increasing traction in non-energy exports will eventually see this sector leading growth by the second half of 2015. It is doubtful that Canada’s growth scenario will be in line with this script. And while there has recently been a bit of pessimism over the U.S., a policy risk that not surprisingly sees little discussion is the case of better than expected Canadian and U.S. growth in the second half of this year and in 2016. Meanwhile, the market unwound rate cut expectations following the April announcement.

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