By Michael O’Neill
Bank of Canada (BoC) officials read the economic tea-leaves in January then proclaimed, “Governing Council continues to judge that the policy interest rate will need to rise over time into a neutral range to achieve the inflation target.” They read them wrong.
The central bank was forced to admit their error. The March 6 policy statement said “the slowdown in the fourth quarter was sharper and more broadly based. Consumer spending and the housing market were soft, despite strong growth in employment and labour income. Both exports and business investment also fell short of expectations. After growing at a pace of 1.8 per cent in 2018, it now appears that the economy will be weaker in the first half of 2019 than the Bank projected in January.” They went on to say “outlook continues to warrant a policy interest rate that is below its neutral range.
Oops. So much for the neutral rate focus. The Canadian dollar got clobbered on the news and may have set the stage for a sharply weaker currency in the coming months.
The BoC deflected blame for their miscue by pointing out the slowdown in the global economy was more widespread and noting that many other central banks acknowledged the same issues.
To be fair, the Bank of Canada isn’t the only central bank doing the “back-step boogie.” The Reserve Bank of Australia issued a somewhat dovish policy statement on March 5. It was followed by a weak GDP report which led one Australian bank to warn of a possible 0.50% interest rate cut by August. The US Fed adopted a “patient, data dependent outlook” to rate increases in 2019 and China downgraded its growth outlook. China adopted a GDP range of 6.0-6.5% for 2019, down from 6.6% GDP growth in 2018, in part due to uncertainty around the ongoing US/China trade negotiations. The European Central Bank is hinting at another round of Targeted Long-Term Refinancing Operations (TLTRO) to stimulate sluggish Eurozone growth
It’s not just central banks concerned about slowing global growth. The Organization for Economic Cooperation and Development (OECD) issued an interim Economic Outlook on March 6. They trimmed their forecasts of 3.5% growth in 2019 and 2020, to 3.3% and 3.4%, respectively. Trade tensions, policy uncertainty, an erosion of business and consumer confidence as well as slowing growth in China were blamed for the decision.
The Canadian dollar was knocked for a loop by the dovish BoC statement. It’s steep decline from 76.16 cents to the US dollar on March 1, to 74.35 cents after the March 6 statement has some technical analysts predicting a steeper slide to as low as 71.00 cents in the coming months, based on Fibonacci retracement levels.
For that to happen, a lot of things must go wrong in Canada and around the world. Some of those issues include each or any combinations of the following: West Texas Intermediate (WTI)oil prices collapsing below $40.00/barrel, China/US or UK/EU trade negotiations failing, sparking a full-fledged trade war. Speaking of wars, Russia could annex some Eastern-bloc nations or China could move against Taiwan. Closer to home, NDP leader, Jagmeet Singh becoming Prime Minister of Canada on October 21.
Barring those events, there are many positives for the Canadian economy. WTI oil prices have rallied 32.5% since the December low and the discount for Alberta’s Western Canada Select (WCS) is only $11.00/b, a vast improvement from discounts as much as $50.00/barrel in Q4 2018. A US/China trade deal combined with Opec production cuts and Venezuela sanctions may drive WTI prices to $70.00/b in the coming months. Higher oil prices will underpin the Canadian dollar.
Federal Finance Minister Bill Morneau tables the Liberal 2019/2020 budget in less than two weeks. A corruption scandal, cabinet minister resignations, and senior current and former MP’s exchanging their “truths” in public forums, argues for a voter friendly, fiscal stimulating budget. That is a likely outcome as the Liberals are losing voter support. An Ipsos poll noted that if an election was held on March 5, the Liberals would lose to Andrew Sheer’s Conservatives by a 9% margin. Federal fiscal stimulus would be a short-term benefit for the Canadian dollar.
A China/US trade deal will trigger demand for the so-called “riskier assets” and the Canadian dollar will benefit. It could be in the cards before the end of the month. The US/China trade talks are reportedly, in “final stages.” On March 6, CNBC said President Trump is motivated to get a deal done, telling advisors “he wanted to enter the election season with the stock market surging.” A couple of days earlier, the Wall Street Journal claimed President Trump and President Xi Jinping would meet near the end of March to announce a formal agreement.
The Bank of Canada anticipated a weak start to Q1 due to the lingering impact of low oil prices and a postal strike so they certainly can’t claim to be overly surprised about the domestic economic performance. Perhaps they weren’t surprised but merely caved to peer pressure after the dovish tilt by most of the major G-10 central banks. The BoC is still focused on its “neutral range” so tea leaves may only have been misinterpreted not misread.