6 reasons why the Bank of Canada won't hike interest rates again this year

Photo by Scott Barbour/Getty Images

Of all the major central banks this year, few have been as busy as the Bank of Canada (BoC).

After lifting interest rates for the first time since 2010 in August, it followed that increase up with another in September, taking its key overnight rate back 1%.

This week it meets again, with markets wondering if the bank will make it a hat-trick of hikes in the past three months.

To Elias Haddad, senior currency strategist at the Commonwealth Bank, while the BoC is likely to upgrade its forecasts for inflation and GDP growth at this meeting, it’s likely to stand pat when it comes to official interest rates.

“With Canada’s economy growing at its fastest annual pace in almost three years, the BoC will likely revise their GDP growth and inflation projections a bit higher in the October Monetary Policy Report,” he said in a note released today.

“We anticipate the BoC to keep interest rates on hold and continue to emphasise that future interest rate adjustments will be data dependent.”

Source: Commonwealth Bank

The view of Haddad mirrors that of broader financial markets who have ascribed only a 20% probability that the BoC will lift interest rates at this meeting.

Haddad says there’s a simple reason why the BoC will resist when it meets on Wednesday — it now has time on it side after preemptively tightening policy in the past two months.

He explains:

The BoC can afford to pause the rest of the year and see how Canada’s economy adjusts to the latest interest rate increases. There are six reasons supporting our view.

First, underlying and headline CPI inflation are below the mid-point of the BoC’s 1-3% target band. Second, the bulk of all jobs created between July and September have been in self employment. Third, export volumes contracted in August at its sharpest annual pace since February 2016. Fourth, retail sales volumes fell in August the most since March 2016. Fifth, house price growth is slowing. Canada’s composite house price index grew at annual pace of 10.75% in September, down from a peak of almost 20% in April. Finally, the BoC’s business outlook survey dipped in Q3 consistent with moderating Canadian economic activity.

While Haddad says the BoC now has time to evaluate how the economy is coping, he still thinks that further policy tightening is likely to arrive in the first half of 2018.

“Our base case scenario remains for the BoC to lift the policy interest rate again in 2018,” he says, adding that he expects rates to rise in April and October.

“Diminishing labour market slack points to continued solid performance in Canadian domestic demand activity.

“Additionally, indicators of capacity pressures suggests Canada’s output gap is on track to close by year-end. This will ultimately translate to higher inflation.”

The output gap is the difference between actual output of an economy and its potential output operating at full capacity.

And given the current outlook, Haddad says the risks are that the BoC will hike interest rates earlier than he expects, potentially as soon as its meeting in January next year.

Markets currently attach a 74% probability that the BoC will increase interest rates by 25 basis points at this meeting, taking official interest rates back to the highest level since late 2008.

The Bank of Canada’s October monetary policy decision will be released at 1am AEDT on Thursday.

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