Bank of Canada rate decision downplays job strength; analysts puzzled

FILE PHOTO - Bank of Canada Governor Stephen Poloz speaks during a news conference in Ottawa
FILE PHOTO - Bank of Canada Governor Stephen Poloz speaks during a news conference in Ottawa, Ontario, Canada, October 25, 2017. REUTERS/Chris Wattie

December 7, 2017

By Leah Schnurr and Andrea Hopkins

OTTAWA (Reuters) – The Bank of Canada has insisted its interest rate decisions are data-dependent, yet analysts were puzzled this week when policy makers took a more cautious tone than strong domestic data would suggest.

The central bank’s decision on Wednesday to leave rates unchanged at 1 percent was largely expected and the statement accompanying the rate decision noted “very strong” employment growth and improving wages.

But the cautious tone of the bank, which noted “ongoing – albeit diminishing – slack in the labor market,” perplexed analysts, and the Canadian dollar staggered as investors pushed back expectations for the next hike.

“The bank has championed this message of data dependence and when the data is suggesting a hike they are reluctant to do so,” which makes predicting the bank’s behavior very hard, said Mazen Issa, senior foreign exchange strategist at TD Securities.

Governor Stephen Poloz and other top officials have stressed in recent months that the bank’s policy decisions would be based on incoming data. But the tone of this week’s statement suggested policymakers were instead more concerned about trade tensions with the United States and vulnerability of Canadian consumers to higher rates, analysts said.

“When you provide certain criteria that are being met but are not being followed through – except to go the other way – it is very indicative I think of a policy process that is constantly in flux,” Issa said.

The bank’s statement did say the global outlook remained “subject to considerable uncertainty,” notably about geopolitical uncertainty and trade policy. The Bank of Canada did not comment further on Thursday.

Worries about the North American Free Trade Agreement, which U.S. President Donald Trump has threatened to terminate, were likely the biggest factor prompting the Bank of Canada to keep a dovish message, said Krishen Rangasamy, senior economist at National Bank.

He wondered why policymakers were not more frank about NAFTA uncertainty and focused their statement on the labor market instead.

“For them to actually point to labor market slack when there isn’t any (slack) is a bit questionable for me,” Rangasamy said.

The risk of staying on hold when all the data point to strong growth and looming inflation pressures is it feeds financial stability concerns, given record household debt that thrives on cheap money.

Economists said they believed the Bank of Canada is also wary that Canadian consumers could face higher borrowing costs if the bond market prices in expectations of aggressive rate increases. A dovish tone could keep markets in check.

Still, Sebastien Lavoie, chief economist at Laurentian Bank Securities, said the bank was prudent in not over-reacting to wage growth acceleration in the volatile jobs report.

“The outlook is still foggy. You would need a lot more short-term strength for the bank to shift the needle,” said Lavoie.

The dovish statement reduced market bets of a January hike to just 28 percent from 41 percent ahead of the announcement. <BOCWATCH>

But with the uncertainty over how policymakers will characterize incoming data and surprise moves from the central bank in the past, most economists are viewing each meeting as “live” as they try to suss out the future policy path.

“I do think it’s more of a gut feel, shoot from the hip process as opposed to something that is a little more systematic,” said Issa.

(Additional reporting by Fergal Smith in Toronto; Editing by David Gregorio)