This week, the Bank of Canada will have its interest rate decision and publish its latest update of the Canadian economy’s outlook in the MPR. The market seems certain that there will be no move on rates and that the update on the economy will exude a neutral odour.
The economy is at the stage when the closure of the output gap has firmed core inflation to near target, as seen in the Bank’s three measures, but the pressure for inflation to significantly exceed the target in the future is abating as aggregate demand is rapidly softening to potential or below. In past cycles, the cause of this downshift may have been the result of tighter financial conditions initiated by the Bank but in present day Canada it seems to be more the result of persistent protectionist trade fears and from actions taken by our governments and regulators.
Unless you think our politicians and regulators can get their act together quickly, these downward forces on growth are likely to remain in place for a while. The recalibration of measures directed toward housing, trade concerns, the absorption of minimum wage hikes, delays around major infrastructure projects and resource production being trapped by transportation bottle necks and poor intra-provincial relations will not be going away anytime soon.
The MPR will give “lip service” to how policy will have to gradually tighten to ensure aggregate demand growth aligns with the potential growth of the economy to ensure the inflation target is maintained sometime out in the future. But the reality is that much of this “tightening” is being done as a result of actions taken by other authorities. This puts the onus back onto monetary policy to lean against these negatives to try and keep growth somewhere around potential. Reality may force the Bank to be more dovish than the market expects.
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