Bank of Canada Leaves Policy Rate at 1%

Oil price plunge will weigh on inflation, Canadian economy, says central bank
December 3, 2014 Updated: December 3, 2014

OTTAWA—As widely expected once again, the Bank of Canada, in its Dec. 3 interest rate announcement, left the overnight target rate at 1 percent given the offsetting factors of an improving economy and falling energy prices.

The positive effects of a stronger U.S. economy and weaker Canadian dollar continue to benefit exports, and the Bank noted in its press release that the output gap looks smaller than projected in October’s Monetary Policy Report (MPR). However, the fall in oil prices, which was exacerbated after the Nov. 27 OPEC meeting, poses “an important downside risk to the inflation profile.”

Oil (West Texas Intermediate) was hovering around US$80 at the time of the Bank’s last set of projections; WTI is trading near US$67.50 the morning of Dec. 3.

Canada’s central bank did acknowledge “inflation has risen by more than expected,” but maintained its stance that this is mainly due to temporary effects such as the weaker Canadian dollar and items such as telecommunications and meat.

In the October MPR, the inflation profile was projected to come down to around the 2 percent target on a sustained basis through to 2016. While the consumer price index (CPI) surprised on the high side at 2.4 percent in October, with current core inflation the highest in over two years, the risk highlighted is that lower oil prices will take inflation meaningfully below target.

While the Bank had forecasted 2.3 percent GDP growth in October, it came in at 2.8 percent. The central bank noted this “broadening recovery” with the amount of business investment being upgraded from October. This is a positive for the economy in that growth is desired from business investment and exports and not from a rise in consumer debt loads.

While the economy is clearly showing signs of improvement, Canada’s labour market is not keeping up. With the unemployment rate at a post-recession low of 6.5 percent, the Bank points out that “significant slack” still exists in the economy as indicated by the labour market. What’s behind this is that the proportion of involuntary part-time workers remains elevated and that total hours worked are basically flat.

At the time of the Bank’s October MPR, markets were slowly emerging from a period of increased volatility and risk aversion. While equity markets and bond yields both in Canada and south of the border are higher now than then, the Canadian dollar is about a cent weaker against the U.S. dollar. Net-net, the Bank sees financial conditions as having eased further also due to further accommodative measures enacted by the Bank of Japan and the European Central Bank.

After the release, the Canadian dollar strengthened slightly against the U.S. dollar by 0.3 to 88 cents.

Financial stability risks stemming from household debt levels were singled out as significant and the central bank is growing increasingly concerned. The housing market continues to be a challenge with price increases from Vancouver, Toronto, and Calgary skewing the nation-wide picture, but auto loans and consumer debt are also factors causing Canadian consumers’ balance sheets to move in the wrong direction.

The Bank is no longer providing forward guidance on the direction of its next move to interest rates. Their providing of a “bias” for the next move in rates was last seen in September’s press release.

The Bank of Canada’s next interest rate announcement date is Jan. 21, 2015, when full economic projections and the quarterly monetary policy report will also be released.

Follow Rahul on Twitter: @RV_ETBiz