Canada's policy interest rate unchanged as economy evolves in line with BoC expectations

The Bank of Canada left its key policy rate unchanged at 0.50% today. The Bank judges the current level to be appropriate following its decision to cut the rate from 0.75% in July.

Inflation continues to move in line with the Bank of Canada's expectations, as core inflation remains close to the 2% target. Economic slack, which places downward pressure on core inflation, has been offset by the deprecation of the Canadian dollar and some sector-specific factors. In contrast, headline inflation continues to be held back by the low level of energy prices.

The Bank sees the growth outlook as evolving in line with the July Monetary Policy Report, which expects a relatively sharp rebound in growth in the third quarter, with strong growth thereafter. The Bank continues to see growth as underpinned by household spending, and a recovery in the United States (with positive implications for Canadian exports). The Bank further sees the recent export data as helping confirm that exchange rate-sensitive exports are regaining momentum.

Increasing uncertainty, particularly related to China, has resulted in market volatility and lower commodity prices, but the lower loonie is helping to absorb some of this impact. Financial stability risks are seen to be evolving as expected. As such, the Bank considers the current level of the policy rate as appropriate for balancing stability risks and the inflation targeting mandate.

TD Economics notes:

• The Bank's decision to leave rates unchanged was not surprising. In its last published forecast in July, the central bank had predicted a second consecutive drop in real GDP in Q2, followed by a resumption of moderate growth beginning in Q3. In recent weeks, the economy's performance has been unfolding in line with these expectations.

• Looking ahead, we doubt that the Bank's outlook (which will be updated in October) has changed materially. While the lower-than-expected trajectory of oil prices will be a dampening influence on near-term growth and inflation, further downward pressure on both the Canadian dollar and reduced government bond yields will likely provide offsetting stimuli.

• We see decent growth of as much as 2.5% (annualized) in the second half of 2015, followed by moderate gains of around 2% thereafter. This is sufficient to close the output gap by late 2017, in line with recent Bank of Canada communications. As such, the current level of interest rates appear to be sufficiently accommodative.

• That said, risks to the outlook abound, and are tilted to the downside. In particular, commodity prices remain weak, with a high degree of uncertainty around the Chinese growth outlook. While our expectation is for rates to remain on hold, we cannot rule out the possibility of another rate cut should the external environment deteriorate meaningfully.