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Bank of Canada Holds Rates Steady as U.S. Tariff Plan Weighs on Outlook -- 2nd Update

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03/07/2018 | 07:32pm CEST

By Kim Mackrael

OTTAWA -- The Bank of Canada on Wednesday left its benchmark interest rate unchanged and ramped up its warnings over trade after the U.S. last week announced plans for global tariffs on steel and aluminum.

The decision to keep the benchmark interest rate at 1.25% was widely anticipated by economists, with many saying that worries over Canada's trade ties with the U.S. reinforced their expectations that the central bank wouldn't make any policy changes. U.S. President Donald Trump last week pledged to impose tariffs on steel and aluminum imports, a move he later connected to continuing efforts to renegotiate the terms of the North American Free Trade Agreement.

"In the United States, new government spending and previously announced tax cuts are anticipated to boost growth in 2018 and 2019," the central bank's governing council said in a statement that didn't explicitly mention Nafta or the proposed U.S. tariffs. "However, trade policy developments are an important and growing source of uncertainty for the global and Canadian outlooks."

Bank of Nova Scotia economist Derek Holt said the central bank's warning on trade uncertainty used stronger language than earlier statements, when the central bank said Nafta concerns were clouding the economic outlook.

Canada sends roughly three-quarters of its exports to the U.S., representing 20% of total economic output, so any disruption in trade between the two countries could have a significant impact on the Canadian economy.

The rate decision comes amid a series of discouraging economic data in recent weeks: January's trade report, released by Statistics Canada on Wednesday, revealed a sharp drop in both exports and imports in January, with export volumes plunging 3.6% for the biggest decline in four years. The Canadian economy lost a net 88,000 jobs in January, and a Statistics Canada survey released last week suggested business investment could slow considerably this year. Economic growth in the fourth quarter also came in weaker than anticipated.

"Cooling growth left little reason for central bankers to rush another rate hike, but U.S. steel and aluminum tariffs sealed the deal," CIBC World Markets economist Royce Mendes said after the rate decision was released. He said CIBC anticipates just one more interest rate increase in 2018.

The Bank of Canada has raised its key rate three times since mid-2017, most recently in January. On Wednesday, it said that while the economic outlook is expected to warrant higher interest rates over time, some continued monetary policy accommodation likely will be needed.

The 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," the central bank said in its statement.

Royal Bank of Canada economist Josh Nye said it is unlikely that proposed U.S. tariffs alone would change the central bank's thinking. "But if tit-for-tat measures escalate into a full-blown trade war -- and to be clear, we aren't nearly there yet -- the [Bank of Canada] would have to rethink their tightening bias," he said.

The central bank said Wednesday that Canada's economy grew 3% in 2017, matching its earlier projection, but noted that growth in the fourth quarter was slower than anticipated. Some of the weakness in the quarter was due to higher imports, the bank said, which mainly reflected stronger business investment.

It said some housing demand appears to have been pulled forward in late 2017, before new mortgage-financing rules came into effect.

Inflation is running close to the Bank of Canada's 2% target, it said, while measures of underlying inflation have edged up, suggesting the economy is operating near capacity. The central bank said inflation data is fluctuating because of temporary factors linked to gasoline, electricity and recent changes to minimum-wage laws in some regions of the country.

The Bank of Canada's next interest-rate decision is scheduled for April 18.

Write to Kim Mackrael at [email protected]

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