CAD: A marginally less dovish Bank of Canada – Deutsche Bank

Sebastien Galy, Macro Strategist at Deutsche Bank, expects that the Bank of Canada is likely to take a marginally less dovish stance at its meeting on Wednesday.

Key Quotes

“It should still take a few more months for the Bank of Canada to turn to a tightening bias and eventually hike by year-end, followed by a steady pace of tightening in 2018. Very little of this is expected in Canada for 2017 and especially 2018.”

“Canada’s output gap is steadily closing, driven by robust consumption and a recovery in commodity prices. Growth is now at 2.3% YoY above the 1.8% potential growth. Since the January 18th Monetary Policy Report, the participation rate has been increasing as unemployment ticked down to 6.7% close to the 6.5% level, below which tighter labor markets lead to inflation, according to OECD calculations. Meanwhile, capacity utilization is close to 2014 levels though some slack remains. These factors have yet to translate to stronger wage growth, hours worked or an upward trend in CPI median stuck at 1.9% for the past four months. This leaves the Bank of Canada with a dovish stance waiting as long as possible, much as the Fed did. Month after month of labor tightening has hence an asymmetrically strong impact on the eventual turn in the Bank of Canada stance. At one point, the Bank of Canada will start to catch up to the Fed and the likelihood rapidly increases in the second half of the year.”

“The Bank of Canada should revise upwards its 2017 forecast as the economy continues to grow at a decent clip and headwinds such as the threats of aggressive NAFTA negotiations and a Border Adjustment Tax have largely disappeared. This is even as the Bank will need to revise lower the expected fiscal impulse from the US. From a financial stability point of view, interest rates are simply too low for too long. Vancouver’s market was only temporarily slowed down by a twenty percent tax, while Toronto and more broadly condos continue to roar. Counter-cyclical measures are proving far from effective but are likely to intensify to give the Bank of Canada more time.”