Photographer: Brent Lewin/Bloomberg

Bank of Canada Reiterates Caution in Holding Rates Steady

Updated on
  • Central bank leaves benchmark interest rate at 1 percent
  • Sees ongoing slack in labor market, makes no mention of dollar

The Bank of Canada kept borrowing costs on hold at its last interest rate decision of 2017 and reiterated it will be “cautious” with future moves, indicating it’s in no rush to cool an economy that is very close to capacity.

Policy makers led by Governor Stephen Poloz left the benchmark overnight rate at 1 percent, as the market expected. It’s the second straight hold after consecutive hikes in July and September.

Even as it acknowledges borrowing costs will eventually need to rise, the Bank of Canada is handling the normalization of rates very carefully, wary of triggering another downturn. One argument, repeated Wednesday, is that geopolitical uncertainties remain around U.S. trade policies.

“While higher interest rates will likely be required over time, Governing Council will continue to be cautious,” the Ottawa-based central bank said in its statement. “The current stance of monetary policy remains appropriate.”

The Canadian dollar reversed gains after the statement, weakening 0.7 percent to C$1.2777 per U.S. dollar at 11:10 a.m. in Toronto. Yields on Canadian government bonds fell across all maturities, with the rate on the country’s two-year bonds dropping four basis points to 1.5 percent.

Swaps trading suggests investors pushed back their expectations for the next rate increase, with the likelihood of a hike in the first quarter now at 60 percent from as high as 75 percent earlier this week.

“Today’s communique abruptly pulled the rug out from underneath rates markets,” TD Securities strategists led by Frederick Demers wrote in a note, adding the drop in short-term yields could go further if Poloz conveys a dovish tone at a speech Dec. 14.

Higher rates will eventually be needed to account for an economy that’s been one of the strongest in the developed world with a jobs market on a tear. Even with an anticipated second-half slowdown, Canada is headed for 3 percent growth this year. Its unemployment rate, meanwhile, has fallen to the lowest in a decade.

By the central bank’s own measure, interest rates are still a full 2 percentage points below what it would consider “neutral.”

In its statement, the Bank of Canada gave a nod to the nation’s employment strength and recent wage gains. But it stuck to its assessment that excess labor capacity remains. “Despite rising employment and participation rates, other indicators point to ongoing -- albeit diminishing -- slack in the labor market,” policy makers said.

Removing the reference to labor slack would have been regarded as a hawkish move that could be suggestive of an interest rate increase as early as January.

“There was fear they could overemphasize the job figure but they were as balanced as they could be,” said Mark Chandler, head of fixed income research at Royal Bank of Canada.

Read a history of the Bank of Canada’s rate decisions since 2001

The central bank cited buoyant global growth, higher oil prices and eased financial conditions, but cautioned the “global outlook remains subject to considerable uncertainty, notably about geopolitical developments and trade policies.”

It also said recent Canadian economic data are in line with its October projections, which “was for growth to moderate while remaining above potential in the second half of 2017.”

The central bank, meanwhile, downplayed recent revisions to gross domestic product that suggest historical output was higher than initially estimated, saying the new data may not necessarily imply tighter capacity conditions.

One change in the statement was the removal of any reference to the Canadian dollar. In October, the dollar’s appreciation earlier this year was cited as a factor for slower exports. The loonie has, however, slumped since September.

One argument against rate increases has been weak inflation, which has undershot the central bank’s 2 percent target for years. Policy makers acknowledged a pick-up in core inflation measures that reflects “the continued absorption of economic slack”, while higher-than-anticipated headline inflation has been boosted in the “short-term by temporary factors, particularly gasoline prices.”

— With assistance by Erik Hertzberg, and Maciej Onoszko

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