A Nervous Governor

This week the Bank of Canada announced that it was keeping its overnight rate unchanged and released its latest outlook for the Canadian economy.  The projected growth rates and their profile were very similar to those published in October but they came with a major caveat.  The Bank stressed the large amount of uncertainty surrounding their outlook emanating from possible US fiscal policy actions and their impact on Canada, specifically around measures that impact trade.  

Despite the published outlook that has the economy growing well above potential in 2017 and 2018, the Governor seemed to go out of his way at the press conference to emphasis the negatives.  The risk that the US economy may strengthen further was countered by his view that our exports may not benefit to the same extent as they did in the past.  Recent positive data (employment, trade and the Business Outlook Survey) was downplayed.  He underlined the narrowness and precariousness of the Bank’s projections for above potential growth.  He explained that the outlooks for consumption, investment and net exports were not sufficient to get total economic growth up to potential but needed the announced federal fiscal measures to be finally implemented to reach the projected levels.  To date this stimulus has not been seen in the data.  

The Governor also reminded his audience of the headwinds coming from the financial markets.  Since the US election, domestic yields had backed up significantly in sympathy with treasuries and our dollar had notably appreciated against other countries that compete with us to export to the US.  He reiterated that tightening financial conditions are not conducive to supporting an economy like Canada that has a high degree of economic slack.  

It should not be surprising then that the Governor was not going to encourage further tightening with his comments.  Hence his emphasis on the negatives. If that was too subtle, when asked if a rate cut was still a possibility, he suggested that if trade protectionism became a reality and the closing of the output gap in a timely manner was at risk, that he had the room to act.    

The market responded accordingly to the Governor’s comments with front end yields moving lower and the currency depreciating against its US counterpart.  Whether the market’s reaction was overdone, as some analysts claim, is dependent on how likely Canada finds itself the victim of a drive-by shooting caused by damaging US protection policies.  The hurdle to cut would be very high (and I believe the result of any cuts would be futile) but policies that are expected to have a significant detrimental impact on our exports would warrant the Bank taking action to achieve its inflation mandate.  How likely this is and its timing depends on our good friend and his advisors to the south.   To date, it is still too early to determine whose voices Trump will listen to (and if they are even on this planet) about economic policy.  Hearing him at his inauguration cry out the slogan “Buy American, Hire American” tells me the probability of the Bank’s next move being a cut is not zero.