Preview of the Bank of Canada interest rate decision on March 7, 2018

Key details:

  • The statement will be published at 10 am ET (1500 GMT) Wednesday
  • There is no press conference but the BOC's Lane is holding a speech Thursday to talk about the BOC decision at 3:35 pm ET
  • Trade balance data to be released 90 minutes before BOC decision
  • The OIS market is pricing a 13.2% chance of a hike

The Bank of Canada has a tough job on its hands. It needs to maintain a degree of optimism to justify the three hikes in the past 8 months while highlighting worries about an economic slowdown, trade and housing.

Trade

What has been rocking the Canadian dollar lately is worries about a trade war after Trump said he will put a 25% tariff on steel imports and 10% on aluminum from all countries, including Canada.

In terms of steel and aluminum, both Canada and the US are each others' largest trade partner.

In the aftermath, USD/CAD rose to the highest since July. That move was tempered Tuesday but hints Canada could be spared from tariffs but there will almost-certainly be no clarity by the time of the BOC decision.

At the same time, another round of NAFTA negotiations has wrapped up with only modest progress and time is running out ahead of the Mexican election.

Economy

Canada ended 2017 with a strong series of economic data points but that abruptly reversed in the past three months. The latest major releases were:

  • Q4 GDP at 1.7% vs 2.0% expected
  • Retail sales -0.8% vs -0.1% expected
  • Retail sales ex autos -1.8% vs +0.3% expected
  • Wholesale sales -0.5% vs +0.4% expected
  • Jan employment -88.0K vs +10.0K expected
  • CPI 1.7% vs 1.5% expected

Even on the CPI front where inflation was a bit higher, it was still sequentially lower from the previous reading. On net, Citi's economic surprise index for Canada is the lowest in the major economies, signaling that economists have overestimated how well the economy is doing.

Housing

At the start of the year, the Bank of Canada signaled that it expected housing demand to cool and contributions to GDP from housing to disappear.

"Looking forward, consumption and residential investment are expected to contribute less to growth, given higher interest rates and new mortgage guidelines," the January 17 BOC statement said.

The latest numbers on Toronto home prices showed a 14.6% drop year-over-year and a jump in listings. In Canada, home sales are highly seasonal in part due to the weather so it's likely the BOC will want to monitor closely how the market develops in March-May, when turnover peaks.

A further hit to the Canadian mortgage market has been a climb in 5-year government of Canada bond yields. These are the benchmark for Canadian mortgages and they have risen with BOC moves at the front end and changes in the global fixed income market. The five-year note is trading at 2.22% compared to 1.70% at this time last yea and as low as 0.91% in 2016.

The statement

Don't look for huge changes in the statement. In January, the BOC was already highlighting risks to housing and trade. The latest tariff spat will elevate trade concerns and housing is in largely the same wait-and-see predicament as before.

The biggest change to the main text is likely to be on the economy, which has softened. The January statement said "recent data have been strong" and don't be surprised to see something like a 180-degree reversal to something like "recent data has moderated".

The key part of the statement is the guidance at the end. Here, it's tough to envision a meaningful change. There is already a nod to caution.

While 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.

A surprise would be if the BOC removed the line saying "the economic outlook is expected to warrant higher interest rates over time" but it could be tempered by changing the word 'expected' to 'likely' in a slight downgrade.

What's priced in

The OIS market -- for some reason -- is pricing in a 13.2% chance of a hike on Wednesday. That's out of whack. At most the percentage is about 1% but two surprises from the BOC last year have led to some distrust and that high-ish probability might reflect that.

What's more interesting will be signals going ahead. The next meeting is on April 18 and a 40% chance of a hike is priced in. That's too high and there is a growing likelihood the BOC doesn't hike at all this year.

What is also high is a nearly 50% likelihood that the BOC hikes three or more times this year. I will be shocked if that turns out to be the case.

What's the trade

I think the market is going to rethink the path of Bank of Canada tightening but I expect it will take place more slowly rather than all at once.

The Bank of Canada is already suitably cautious on rates, even if Poloz has redefined the word 'cautious' several times.

On net, I expect a less-hawkish BOC statement and that's likely to cause some Canadian dollar selling but I believe it will be modest, in line with subtle changes to the language. One risk is a virtually unchanged statement and that may create some Canadian dollar buying but, again I wouldn't expect any more than 50 pips on the headline. An equal risk is that the BOC shifts to a more-neutral stance because of trade and economic worries. If so, it will aid the technical breakout in USD/CAD and set the pair on a path to 1.34 in the month ahead.