Growth outlook continues to worsen in Canada

The growth outlook for Canada has continued to worsen. Most importantly, growth data in China has weakened that, coupled with CNY devaluation and insufficiently proactive PBOC, led to a further selloff in commodities, including oil.

At $40/bbl, the WTI price is already well below the BOC assumption of $60/bbl. Excess supply and Fed contemplating a rates liftoff this year point to near-term downside risks to oil prices. Although core inflation has been supported by FX pass-through given CAD depreciation so far, long-dated RRB breakevens have declined to lowest levels since 2009, implying that investors may be questioning the BOC credibility to reach its inflation target in light of the deteriorated growth outlook. 

In this environment the BOC is expected to continue to ease policy. Note that after reaching 25bp in the O/N rate, further cuts may be difficult from a technical standpoint given the risk of significant market functioning impairment in case the repo rate moves to 0 or negative levels. 

The BOC is expected to rely on forward guidance and possibly QE, should further accommodation be needed. However, if the BOC introduces fail delivery fees, proposed in a BOC discussion paper earlier this year, the likelihood of implementing negative rate policy may increase.