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By Brian DePratto
• Dec. 5, 2018
Senior Economist, TD Economics

By Brian DePratto
Senior Economist

Bank of Canada Governor Stephen Poloz spoke in Toronto this morning. His speech was part of the Bank of Canada's 'Economic Progress Report' series, intended to shine more light into the decision-making process that led to yesterday's announcement that the policy rate would be held at 1.75%.

The speech was split into two parts. The first on financial stability/vulnerabilities reinforced Bank of Canada communications and research of recent months. Governor Poloz appears pleased with the progress that has been made towards improving the quality of household borrowing. He was careful to acknowledge that some policies appear to have shifted borrowers towards less regulated lenders and that the overall stock of debt remains relatively risky. Poloz also appears to land firmly in the camp that slower home price growth does more to help first time buyers than rising rates do to impede them.

More interesting was the second part of the speech, focused on the macroeconomic risks and the inflation outlook. Poloz was quite frank, at least by central bank standards. He noted that data since the October rate hike decision has been on "the disappointing side". The details of the Q3 GDP report failed to meet their expectations, and momentum appears lower than expected. Business investment was called out in particular, with the unexpected decline put down to trade uncertainty and the Trans Mountain Pipeline delay. Abstracting from near-term developments, the Governor maintains a positive outlook on the sector, pointing to CUSMA, capacity constraints, and recent tax changes as driving factors.

Oil developments are clearly top of mind. First, the Bank is currently assessing the implications of Statistics Canada's historic data revisions, which now show a much weaker economy through the 2015 and 2016 oil shock – a full assessment will be included as part of the Bank's January 2019 Monetary Policy Report. The more recent developments in the domestic energy market are also seen as having a 'meaningful' impact on the Canadian economy, although the governor downplayed some of the risks by noting that the sector represents a much smaller share of the economy than it did in 2014.

It wasn't all dour, however. We were reminded that these developments are occurring in an economy with an unemployment rate near a 40-year low and inflation that is roughly on-target. Recent developments have not changed the view that the policy interest rate will need to hit its 'neutral' range (2.5% to 3.5% in the Bank of Canada's estimation) to control inflation. But, of course, the route from here to there will be 'decidedly data dependent'.

Key Implications

Introduced this year, the 'Economic Progress Report' speeches that accompany non-MPR interest rate decisions have so far tended to be staid affairs. Today's, however, was a bit on the spicier side as events over the last six weeks have shown just what 'data dependency' means. The Bank of Canada's messaging has gone from hawkish to dovish as commodity shocks and signs of fading momentum have blown the economic narrative off course.

Indeed, among the areas highlighted as concerning by Governor Poloz are the weak business investment numbers, the impact of higher rates as mortgagors renew in coming years, and, of course, recent developments in Canadian oil prices and production.

The ship may still be righted. Recent policy developments bode well for investment and exports (indeed today's trade figures, while hardly signaling a trend, were nevertheless encouraging). The Governor also pointed out that an unemployment rate at a 40-year low is hardly a signal of a weak economy (we'd further reinforce this by noting that core-age employment and participation rates are both at all-time highs).

The bottom line is that recent developments are clearly negative, but there remains a light at the end of the tunnel. As the economy works through the shocks, however, there is clearly less urgency to move rates higher in the near term. There is little to be lost by waiting for confirmation that recent events are indeed temporary, and expected developments in investment, exports, etc. are in fact occurring. Holding off until Spring to move its policy interest rate higher looks like the best way for the Bank of Canada to gain some certainty on the narrative with little cost from an inflation-control perspective.

Message received by financial markets. The probability of a rate hike for January was hovering north of 60% for the last two months, but, between yesterday's Bank of Canada communication and today's speech, those odds have now plummeted, with the most likely timing now matching up our view.

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