BOC monetary policy decision: Assessing future bias

Bank of Canada (BOC) at yesterday’s meeting increased interest rates by 25 basis points after hiking twice last year. With yesterday’s rise, overnight rate is now at 1.25 percent, bank rate at 1.5 percent, and the deposit rate at 1 percent.

But how the bank is planning for future?

Let’s assess the bias in the monetary policy statement.

• BoC laid out reasons for the hike as recent strong data, inflation close to the target, and the economy is operating close to capacity. Cautions only against uncertainties surrounding talks with regard to North American Free Trade Agreement (NAFTA). (Mild hawkish bias)
   
• BoC says that the global economy continues to strengthen, with growth expected to average 3.5 percent over the projection horizon. Growth in advanced economies is projected to be stronger than in the Bank’s October Monetary Policy Report (MPR). There are signs of increasing momentum in the US economy, which will be boosted further by recent tax changes. According to BoC, Canada’s benefit from higher commodity prices are being diluted by the wider spread between global oil price and that of Canada’s. (Hawkish bias)
   
• BoC expects GDP growth to slow to 2.2 percent in 2018 and 1.6 percent in 2019, following an estimated 3.0 percent in 2017. Still, growth is expected to remain above potential through the first quarter of 2018 and then slow to a rate close to the potential for the rest of the projection horizon. (Dovish bias)
   
• According to BoC, consumption and residential investment have been stronger than anticipated, reflecting strong employment growth. Business investment has been increasing at a solid pace, and investment intentions remain positive. Exports have been weaker than expected but apart from cross-border shifts in automotive production, there have been positive signs in most other categories. (Hawkish bias)
   
• BoC expects consumption and residential investment are expected to contribute less to growth going forward, given higher interest rates and new mortgage guidelines, while business investment and exports are expected to contribute more. (Mild hawkish bias)
   
• The Central bank’s outlook takes into account a small benefit to Canada’s economy from stronger US demand arising from recent tax changes. However, as uncertainty about the future of NAFTA is weighing increasingly on the outlook, the Bank has incorporated into its projection additional negative judgment on business investment and trade. (Mild dovish bias)

• Inflation is close to 2 percent and core measures of inflation have edged up, consistent with diminishing slack in the economy. BoC expects CPI inflation to fluctuate in the months ahead as various temporary factors (including gasoline and electricity prices) unwind. Looking through these temporary factors, inflation is expected to remain close to 2 percent over the projection horizon.  (Mild hawkish bias)

• The economic outlook is expected to warrant higher interest rates over time, some continued monetary policy accommodation will likely be needed to keep the economy operating close to potential and inflation on target. Governing Council will remain cautious in considering future policy adjustments, guided by incoming data in assessing the economy’s sensitivity to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation. (Hawkish bias)

With monetary policy wordings, turning more hawkish, we expect the Bank of Canada to hike rates again in 2018 and twice. The Canadian dollar is currently trading at 1.245 per dollar.