Bank of Canada: expect the same old thing

The Bank of Canada has another interest rate decision fast approaching.  I must admit, since the beginning of the year, it has been very entertaining to guess what rabbit they were going to pull out of their hat to justify maintaining their ridiculously accommodative policy.  With each passing decision, we are getting closer to when the output gap is expected to be closed.  When last we heard from them, this was envisioned in the first half of 2018.  Normally with the lags associated with monetary policy, market watchers could pencil in a central bank starting to slowly increase rates closer to neutral, well ahead of when the gap actually closes.  So, right around now.  

To date, the Bank has made it very clear that a rate increase is not in the cards.  Heck, they just took a possible rate cut off the table a few months ago.  They continue to stress that the economy has material room to grow with the size of the output gap remaining significant even with its closure only 3 quarters away.  Recent inflation readings only strengthens this view, particularly given the soggy performance of the three amigos (CPI-common, median, trim).  

The Bank had trained economists and the market to anticipate that the interest rate actions of a inflation targeting Bank would be ultimately determined by the amount of excess demand or supply there was in the economy.  If the output gap was expanding, there was excess supply, there would be downward pressure on prices and rates could be expected to go lower.  The opposite would be expected if there was excess demand and the output gap was closing.  The market could expect to see rates move higher.       

So, here we are with the output gap closing and expected to be gone in less than one year.  There is no indication that growth is slowing significantly below the Bank’s latest MPR outlook but there is also no indication that the narrowing of the output gap has, so far, exerted any upward pressure on core inflation or wages. This begs the question if a domestically focussed Phillips curve framework is still a useful guide for the market to use when trying to determine the timing of monetary policy in Canada under the current regime.  It still seems to be applicable in the US.  

It looks like this Governor will continue to ignore housing inflation and instead wait to see the whites of the three amigos’ eyes before he even thinks of pulling the trigger.  (This gives more time for the youth of our country to get a job and get out of their parents’ basements and it keeps downward pressure on the dollar.)  Despite what nominal growth may be suggesting about the closure of the output gap and what that would normally mean for monetary policy, until core inflation shows some life, the stretched dovish narrative linked to uncertainties and to doubts about the sustainability of growth will continue to dominate their press releases.