Bank of Canada Rate Decision & MPR --- 25 bp cut

It appears the Bank of Canada is getting into the reinsurance business. Following a series of disappointing GDP and trade results, the Bank chose to further trim interest rates today, cutting its key overnight lending rate 25 bps to just 0.50% (leaving it only a quarter point above the all-time low reached during the depths of the 2009 recession). The Bank's first cut in January was billed as an "insurance" move against the possible effects of the oil price shock, and this move is in response to the very real effects of that shock, along with some serial disappointment in non-energy exports. On the latter, the Bank deems that the "extent of the weakness is puzzling", not an admission one sees every day from a central bank.

Besides the highly anticipated rate decision, the Bank also released its quarterly Monetary Policy Report and its updated forecast. The GDP call is a bit more important than usual, with recession chatter running rampant --- and the Bank is now looking for Q2 GDP to drop 0.5% after the 0.6% dip in Q1; although, notably, the Bank did not use the R word. For all of 2015, they slashed their estimate of growth to 1.1% from 1.9% in April (versus our call of 1.5%), and trimmed 2016 to 2.3% from 2.5% (still a bit above our call of 2.2%). Note that the Bank now arguably has the most cautious forecast out there on 2015, and will likely not be disappointed further in coming months. The takeaway here is that it will take another significant disappointment in the economy to get them to cut further, although the market has hastily priced in another half chance of yet another cut.

"The Bank's estimate of growth in Canada in 2015 has been marked down considerably from its April projection. The downward revision reflects further downgrades of business investment plans in the energy sector, as well as weaker-than-expected exports of non-energy commodities and non-commodities.  Real GDP is now projected to have contracted modestly in the first half of the year, resulting in higher excess capacity and additional downward pressure on inflation." This is all the reason they needed to cut rates again. They later note that the output gap will not close until the first half of 2017, versus late 2016 as earlier expected", Says BMO Economics.

"The lower outlook for Canadian growth has increased the downside risks to inflation. While vulnerabilities associated with household imbalances remain elevated and could edge higher, Canada's economy is undergoing a significant and complex adjustment. Additional monetary stimulus is required at this time to help return the economy to full capacity and inflation sustainably to target." The concern about "household imbalances" (i.e. debt) remains, but Poloz has called this a "side effect" that has to be put aside.

"Setting aside these transitory effects, the Bank judges that the underlying trend in inflation is about 1.5 to 1.7 per cent." Even as core remains stuck above 2%, the Bank continues to judge that it is being exaggerated by transitory factors, and real underlying inflation is closer to 1.6% a bit lower than they earlier suggested, noted BMO Economics.

Bottom Line: In what was seen as an absolute toss-up, the Bank came down on the side of the rate cutters owing to the deep cut in their growth estimate for this year. Casting aside concerns about a fire-breathing housing market, a Canadian dollar testing decade-lows, and core CPI consistently above 2%, the Bank is more focused on the hit to growth from the oil shock and the "puzzling" weakness in the non-energy side of the economy. While, the economic clouds will not immediately clear, it is believed that conditions will improve enough to keep them on hold through the rest of this year, added BMO Economics.