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Bank of Canada Leaves Rates Unchanged, Pledges Cautious Policy Approach -- Update

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10/25/2017 | 04:41pm CET
By Paul Vieira 

OTTAWA -- The Bank of Canada on Wednesday left its policy interest rate unchanged at 1% after increases in July and September, vowing to be cautious in future deliberations as growth is expected to slow, wage gains remain subdued and the Trump administration's trade policy poses an "elevated" risk.

The central bank -- which issued both a rate decision and updated quarterly forecast -- said the economy is operating close to capacity, with exports and business investment expected to contribute to growth and help offset a slowdown in domestic consumption. Yet, the Bank of Canada said recent strength in the Canadian dollar means exports will accelerate at a slower-than-expected pace, and the annual inflation rate won't hit 2% until the second half of next year, slightly later than originally forecast. The central bank sets rate policy to hit and maintain 2% inflation.

The central bank said a decline in Canada's unemployment rate to 6.2% "likely overstates the degree of improvement" in the country's labor market, pointing to modest wage gains and below-average hours worked. The persistence of labor-market slack, it said, suggests there is more room for the economy to grow without triggering a material advance in inflation.

"While less monetary policy stimulus will likely be required over time, the governing council will be cautious in making future adjustments to the policy rate," the central bank said. It added that policy makers would analyze incoming data to assess the household sector's sensitivity to higher rates, and the dynamics underlining wage growth and inflation.

Wednesday's move follows quarter-percentage-point increases in July and September. A pause was widely expected by economists surveyed by The Wall Street Journal.

The statement "is clearly a move to a more dovish stance by Bank of Canada," said Nick Exarhos, an economist at CIBC World Markets. He said the statement reinforces CIBC's call that the Bank of Canada will be on pause until the second quarter of 2018.

The decision comes amid a string of economic data that indicate Canadian economic activity has slowed after a stellar run in which the economy grew 3.7% in the 12 months to the end of the second quarter. The Bank of Canada now forecasts gross domestic product will grow just 1.8% annualized in the third quarter, after a 4.5% jump in the previous quarter. Annualized growth should pick up to 2.5% in the final three months of the year. All told, the central bank said 2017 growth is anticipated to hit 3.1%, followed by a slower 2.1% expansion in 2018.

The moderation in growth is fueled in part by the rate rises. Because the level of household debt in Canada sits at a record level, "household spending is likely more sensitive to interest rates," the bank said. In addition, tougher mortgage-financing rules introduced this month by Canada's banking watchdog are estimated to subtract 0.2% from Canadian GDP by the end of 2019, the bank said.

Among the top risks identified by the Bank of Canada to its outlook is the renegotiation of the North American Free Trade Agreement. The "uncertainty around the outcome of NAFTA renegotiations is elevated," the bank said. Growing protectionist pressures in the U.S. and competitiveness challenges could prompt Canadian firms to move production capacity abroad to offset the risk, the central bank said.

Write to Paul Vieira at [email protected]

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