The Bank raised its benchmark interest rate this week, as many in the market expected. More surprisingly, the tone from the documents and the press release seemed aligned with market expectations. In the press conference, the Governor seemed pretty pleased with how things evolved, saying the market digested the firmer data as it was released and repriced itself on an ongoing basis, allowing the Bank to ratify the analysis with its increase in the target rate. That is how it is suppose to happen, he said, when the Bank is data dependent.
There was nothing that truly stood out from the MPR document. NAFTA continues to be the fly in the ointment. The uncertainty surrounding the outcome of the negotiations is already putting a damper on trade and business investment, subduing aggregate demand from where it could be and potentially having a longer-term negative impact on the economy’s capacity to produce. If the US decides to pull itself out of the negotiations, then all bets are off with respect to the outlook.
All said, the Bank’s forecast was relatively optimistic, with growth remaining firm and then gradually slowing down to around potential by 2019. Although the contributors of growth do shift, the overall economy appears to have momentum and be on a firm basis. The risk to the positive outlook is an exogenous shock. Something like the US pulling out of NAFTA.
The Governor tried to get ahead of the market, fearing that it may start trading off of Nafta headlines, creating unnecessary volatility by indicating that the Bank would not view this as a binary event. He is right that the decision is not binary. It will not have a significant immediate impact on the real economy. Just because one of the participants decides to opt out, the trading world will not cease to exist. It will potentially take years before the trade framework that replaces NAFTA will be settled on. But in the meantime, the market will of course remain vulnerable to NAFTA headlines and, being forward looking, will rightfully react on any news as any post-NAFTA trade regime will be sub-optimal to the current one and need some degree of additional monetary stimulus.
In addition to the NAFTA headlines which will keep risks to front end rates to the downside, there was other evidence that the Bank remains dovish. They continue to seek reasons to justify not being as aggressive as a pure read of the output gap and the data would suggest. Governing Council continues to want to believe that we are now in a sweet spot where stronger demand leads to greater supply with increased investment, more business creation and new hires. They seem to want to let this run as far as they can. They have come up with a new and improved measure of wage growth, wage-common, that just happens to show that wage growth is slower than normally reported and that the best determinant of this new measure is labour slack. The fact that this measure is running just above the rate of inflation suggests to them that slack continues to exist. And finally, to stress that point, the Governor again at the press conference defied the analysis of many and said he was still preoccupied with Karim holed-up in his parents’ basement unable to get that job in management.
When you add all of this to their concern about the sensitivity of the leveraged household sector to higher rates, you have a central bank that seems willing to be extremely patient. It will take some sharp upward surprises for both wages and their core measures before anything close to a hawkish bent makes its way into the building.
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