When is material, material?

The Bank of Canada kept its key benchmark unchanged.  The accompanying press release was read by the market to be slightly less dovish than expected.  

In their update, the Bank saw the global economy gaining traction, the US rebounding from its first quarter slumber and importantly said some positive things about the domestic economy.  They noted the firm labour market had lead to an improvement in consumer spending, that the adjustment to lower oil prices was now largely complete and that there had been some early indications of a return of business investment.  All good. 

At the same time, they noted that exports remained subdued and stressed again that their global and domestic outlook continues to be clouded by global uncertainties.  They also commented that the recently imposed measures aimed at the housing market have not yet had a substantial cooling effect.  As has been consistent with their glass half empty approach, they stated that second quarter growth would likely show some moderation from the very strong growth experienced in the first quarter.

Inflation was said to be broadly in line with their MPR outlook, with the headline number being temporarily pulled down by declining food prices.  As they did in April’s press release, they highlighted that the three amigos (measures of underlying inflation) remained well below their 2% target and that wage growth had been subdued.  In April they concluded that this was consistent with ongoing material excess capacity.  Now, although neither the core measures or wages has shown any new signs of life,  they claim that these two factors are consistent with ongoing excess capacity.  The word “material” was dropped. 

So was the word “material” dropped because the economy has performed better than expected thus leaving us with a smaller output gap than envisioned at this point, or was it dropped because the economy is tracking as expected and the dropping of the word recognizes that we are now six weeks closer to the closing of the gap in the first half of next year than we were in April.

Regardless of why the word was dropped,  with the output gap already expected to close early next year at the latest, and with the strongest economy in the G-7, one can easily justify an immediate move to start tightening policy and getting their overnight rate closer towards neutral.  However, the Bank appears to be in no hurry in getting that show on the road.  There is no panic, let alone any explicit thought of them risking getting behind the curve.   They claim that the current degree of monetary stimulus is appropriate, at present.  

It would seem that the Governor remains skeptical about the sustainability of the last few quarters’ reported growth (still too much household-debt based activity and not enough business investment and exports) and he continues to believe the dampening effects of the huge amount of uncertainty on the economy need to be offset by monetary stimulus.  

However, if the economy continues to chug along and even moderates from its current pace, as they suggest it will, the output gap will still be rapidly diminishing.  With each passing decision, they will risk getting further and further behind the curve.  If the Governor is waiting for the optimal point to start raising rates, time is not on his side.  The first move will have to happen before growth is declared to be sustainable, before there is clarity around all the uncertainties and well before the three amigos hit 2%. The risk is quickly becoming that the first move will come much sooner than he would like and before the markets expect.