World Economy

Canada Economy Backs Cautious Rate Hikes

April data shows no sharp pick-up in underlying inflation while the overall growth was better-than-expected in first quarter
Higher oil prices mean more money in the oil industry’s pockets and that will spillover into wages, jobs and tax revenue.Higher oil prices mean more money in the oil industry’s pockets and that will spillover into wages, jobs and tax revenue.

Canada’s economy continues to show signs of strength, but not enough to fuel inflation and prompt aggressive rate hikes—a scenario that validates the Bank of Canada’s cautious stance on monetary policy.

Inflation figures Friday by Statistics Canada showed few signs of any sharp pick-up in price pressures even as the economy operates near its full capacity and gasoline prices are rising. A separate retail sales report showed signs of life from consumers, who had been scaling back recently. The pair of releases adds to a run of data—including an unexpected jump in both imports and exports—that underscore demand remains solid, Bloomberg reported.

Robust growth accompanied by benign underlying inflation marks a progression for the economy that reinforces expectations Bank of Canada policy makers will move ahead with more interest rate increases, but only gradually. After three hikes since last July, investors are anticipating two more increases this year: in July and October.

“They would say things are pretty much unfolding as expected,” Mark Chandler, head of fixed income research at RBC Capital Markets in Toronto, said by phone. “You don’t accelerate the time table, you don’t push it back, you just follow through on it.”

Friday’s inflation data showed the consumer price index rising at an annual pace of 2.2% in April, down from 2.3% in March. A narrower gauge of core prices closely tracked by the central bank was little changed at 2%.

Retailers, meanwhile, recorded their largest sales gain in five months in March as the nation’s households continued their car-buying binge.

 Rate Hike

The Canadian dollar fell on the data, trading down 0.5% to C$1.2877 per US dollar, largely due to investors paring down bets on a move at the next rate announcement May 30. The implied odds of a hike this month are now 28%, versus nearly 40% Thursday.

“The odds of a May rate hike were scaled back notably in the wake of the data—perhaps reflecting the fact that the previous pricing required a very strong set of figures today, and that didn’t happen,” Doug Porter, chief economist at Bank of Montreal, said in a note to investors.

After a slowdown that began in the second half of last year, most economists are anticipating growth will return to an above 2% pace in coming months and continue to put pressure on Bank of Canada Governor Stephen Poloz to raise interest rates.

A slump in first-quarter growth is also turning out to be less severe than initially feared. The economy probably expanded at just under 2% in the first three months of 2018, better than the 1.3% predicted by the central bank last month.

Statistics Canada will release first-quarter GDP data on May 31, the day after Poloz’s rate decision. At the bank’s last rate decision April 18, officials reiterated they are in no rush to thwart the current expansion with aggressive rate hikes, particularly when plenty of headwinds remain such as uncertainty on global trade policy and the future of the North American Free Trade Agreement.

 Rising Oil Prices

While the rally in oil prices threatens to be a drag on global growth, it’s a good thing for Canada, the world’s fourth largest producer.

Yet whether the benefits are large enough to make a big difference is an open question, given doubts around the sustainability of the price increases and obstacles to investment like rail and pipeline constraints.

While more expensive oil should reinforce expectations that borrowing costs are eventually going higher, most economists predict little impact on growth, and views are mixed on what it means for the Bank of Canada’s projected rate-hike path in the near term.

According to Bank of Nova Scotia economist Derek Holt, the mere fact oil prices are moving higher has hawkish implications for the central bank and could potentially move the dial on rate increases.

The most immediate impact on the economy is a boost to national income. Even if Canada doesn’t produce an extra barrel of oil beyond the roughly 4.9 million it churns out daily, higher prices mean more money in the oil industry’s pockets and that will spillover into wages, jobs and tax revenue.

Higher oil prices “fit into a broader picture that suggests there should be no hesitation to continue along a hiking path in the near term,” Holt said.


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