Bank of Canada expected to be unmoved on Wednesday but investment manager warns growth is slowing
More than one person has uttered the words “extreme market anxiety” to describe investors’ mood during the opening weeks of 2020.
But there is a good chance the Bank of Canada will throw the “Negative Nancys” some emotional stability this week when it meets for the first time this decade. Before the holidays, many analysts predicted that outgoing Governor, Stephen Poloz, could even start the year with a cut – the first since October 2018 – but that now seems unlikely based on the strength of the economy and high inflation.
Additionally, the labour statistics are good while much-mentioned concern at trade tensions appear to have eased. Given the boost to markets from the “lower for longer” policy both here and in the US, and the help this would provide our underperforming banks, a BoC decision to stay pat is expected to be widely welcomed.
Looking farther down the road, however, is where some tough decisions may need to be made.
In Manulife Investment Management’s 2020 Global Macro Outlook, led by Frances Donald, Global Chief Economist and Global Head of Macro Strategy, it warned that growth is slowing and that the BoC will need to strike a balance between inflation that’s in line with its target, and its instinct to avoid stimulating an already highly leveraged economy. It added that if Canada does see improved growth, it’ll likely come through business investment.
Significantly, Donald anticipates two rate cuts in the second half of 2020 as growth slows, although admitted this is a low-conviction call. Meanwhile, the C.D. Howe Institute’s Monetary Policy Council (MPC) recommended that the Bank of Canada keep its target for the overnight rate at 1.75% until July but cut it to 1.50% by 2021, meaning just one cut in 2020.
Donald said: “However, there’re good reasons to believe that if any easing does indeed materialize, the BoC will be doing so reluctantly; after all, wage and price pressures remain sizable. From an inflation perspective, Canada is one of the few major developed-market economies to have hit its target. Meanwhile, on the wage front, hourly earnings have been running materially higher than even the most elevated assumptions in the United States.”
Manulife’s outlook explained that the bar to cutting rates is still high and that given extremely elevated debt levels, the BoC will want to make sure the broader economic benefits of cutting rates outweigh the costs of encouraging further leverage.
It added: “Moreover, it’s unclear whether lower interest rates would be an effective tool. While more accommodative policy would help to weaken the Canadian dollar and keep financial conditions easy, it’s also plausible that any such moves could be less effective given the Canadian consumer’s limited capacity (and, possibly, willingness) to take on additional debt.”
Hence the importance of Canadian business investment picking up, although Donald did offer moderate tailwinds of hope like the completion of USMCA, a stabilization/recovery in U.S. and European growth, improvements in U.S.-China trade relations, and some pent-up demand.
“But the risks to the broader economy are firmly on the downside, and the absence of business spending or hiring could significantly drag on Canadian growth. From a policy perspective, the unfortunate reality is that there’s little the BoC can do, given that business investment decisions—at this juncture—don’t appear to be rates related, but a function of external uncertainty.”
In a wider macro view, Manulife Investment Management expects 2020 to be a year of two halves, with the first six months to be characterized by a stabilization followed by an acceleration during the latter part of the year.
It read: “However, we don’t think that the recovery will be synchronized, with Europe turning first, before the U.S. stabilizes and eventually, China. Against a backdrop framed by the ongoing trade dispute, we expect only a modest acceleration in China, a view that’s underscored by our belief that any forthcoming stimulus packages will be small and domestically focused.
“We expect monetary policy—and, increasingly, fiscal policy—to play a key role in reviving global growth. Key global central banks are expected to stay accommodative for an extended period of time. Given the dearth of inflation, this could continue until price level rises and takes root at, or near, official targets. It’s likely to be a multi-year process and could prove beneficial to equities on a structural basis. While currently small, the move toward fiscal stimulus is also an area that could support activity in the second half of the year.”