Bank of Canada slashes outlook as oil, trade and housing concerns weigh

Barrie McKenna Economics Reporter

The Bank of Canada is keeping its key interest rate unchanged in the face of a new grimmer forecast that shows Canada’s economy is slowing down fast.

As it did in December, the central bank left its rate at 1.75 per cent Wednesday as the country takes a hit from lower oil prices, weaker housing activity, the U.S.-China trade clash and the decelerating global economy.

The Bank of Canada insists it remains committed to getting interest rates back up to neutral – the level where they are neither driving the economy forward nor slowing it down – but only “over time.”

“The appropriate pace of rate increases will depend on how the outlook evolves, with a particular focus on developments in oil markets, the Canadian housing market, and global trade policy,” the bank said in a statement.

The bank estimates its neutral rate is about 3 per cent, or 1.25 percentage-points below where the rate is now.

“The Bank of Canada has taken itself out of the rate hike game, and its message . . . suggests that it isn’t quite as sure about when it will come off the sidelines and hike again,” CIBC chief economist Avery Shenfeld said in a research note. “The rate message wasn’t that they were done for good, but rather, that the timing will be a bit more extended.”

The bank also released its first quarterly forecast of 2019, highlighted by a sharp downgrade in GDP growth. The Bank of Canada says the economy will grow just 1.7 per cent this year, down sharply from its previous forecast of 2.1 per cent, and below the estimated 2 per cent pace of 2018.

The bank has hiked five times since mid-2017. In spite of that, longer term interest rates have been falling in recent months and some Canadian lenders are considering cutting rates on home mortgages.

The U.S. Federal Reserve is similarly dialing back plans to raise interest rates as it monitors the shifting economic landscape, including the recent stock market sell-off and the global slowdown.

The Bank of Canada pointed out that the U.S.-China tariff fight is “weighing on” the global economy, depressing the prices for many of the commodities that dominate Canadian exports.

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The bank also highlighted that housing investment has been “weaker than expected” as home buyers adjust to tougher mortgage rules, new restrictions in some provinces on foreign buyers and previous mortgage rate hikes. It is the bank’s first hint that the real estate slump in Toronto and Vancouver may be worse than initially thought.

The Bank of Canada reckons the economic slowdown will be short-lived. It says the economy will grow 2.1 per cent in 2020, up from its previous estimate of 1.9 per cent.

“This revised forecast reflects a temporary slowing in the fourth quarter of 2018 and the first quarter of 2019,” the bank said. “This will open up a modest amount of excess capacity.”

The most significant change in the Bank of Canada’s thinking comes from the drop in oil prices, which is hurting Canadian exports and business investment. The price of crude – now just shy of US$51 a barrel — is 25-per-cent lower than the central bank expected in October.

The recent oil price slump is now projected to shave 0.5 per cent off GDP growth by the end of 2020. That’s roughly a quarter of the impact of the 2014-16 price collapse, the bank said.

The Bank of Canada says investment in Canada’s oil and gas sector will fall 12 per cent this year. The industry now accounts for roughly 15 per cent of business investment in Canada, down from 30 per cent in 2014, reflecting the cancellation and postponement of numerous projects in the western Canadian oil sands.

The grimmer forecast comes in spite of the recent recovery in the price of Western Canadian Select (WCS) – the benchmark for Canadian heavy crude – which was trading at US$40.78 a barrel on Tuesday, just US$9 less than West Texas Intermediate (WTI). That’s down from a differential of more than US$50 in October – driving heavy oil prices below US$10 at their low. Alberta Premier Rachel Notley ordered a production cut of 350,000 barrels a day to take effect on Jan. 1.

And while 2019 won’t be a good year for the economy, the Bank of Canada is calling for a bounce back in 2020. It bases its optimism on a host of factors, including stronger exports, higher non-energy investments, a cheaper Canadian dollar and the positive impact of the renegotiated North American Free Trade Agreement.

Overall, the bank says Canada’s economy is operating “close to capacity,” with unemployment at a 40-year low. But unlike in October, when it suggested the output gap might already be closed, it now says there is likely still some spare capacity in the economy.

Inflation is expected to dip temporarily below the central bank’s guiding 2 per cent target for much of this year, largely because of the effect of lower energy prices.

The bank expects inflation to be back to near target by the third quarter of this year.

It also cautioned that its forecast is subject to “several upside and downside risks,” which are now “roughly balanced.” Among other things, it said trade tension could ease, the price of crude could bounce back and the U.S. economy could keep growing at a healthy clip. Follow Barrie McKenna on Twitter @barriemckenna

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