Bank of Canada Holds, Shrugs Shoulders on the Bias

• The BoC held its policy rate at 2.75%...

• ...and considered a cut, but a ‘clear consensus’ decided against it

• Forecasts and guidance leave the policy rate bias up in the air…

• ...with seven weeks to reassess before the next decision

• The C$ appreciated a touch as slight cut pricing was removed

• Risks may have swung back closer toward the BoC’s darker scenario again...

• ...and they’ll have to answer questions about domestic policy in June and July

• We think the BoC is on a lengthy hold…

• ...with trade tensions and likely fiscal responses adding to nearer term inflation risk

The Bank of Canada left its policy rate unchanged at 2.75% as widely expected despite the closeness of the call. Most Canadian banks got it right including Scotiabank and markets were two-thirds priced for a hold. Overall, the BoC basically threw its hands up in the air with a sigh and a collective ‘beats me’ on the bias. Markets largely shook it all off aside from slight appreciation of CAD as the slight pricing for a cut was struck out.

The concluding paragraphs of the statement said all you need to know by way of the lack of a policy bias:

"Governing Council will proceed carefully, with particular attention to the risks and uncertainties facing the Canadian economy. These include: the extent to which higher tariffs reduce demand for Canadian exports; how much this spills over into business investment, employment and household spending; how much and how quickly cost increases are passed on to consumer prices; and how inflation expectations evolve. Monetary policy cannot resolve trade uncertainty or offset the impacts of a trade war. What it can and must do is maintain price stability for Canadians."

They have seven weeks to further evaluate developments until the next decision sans projections on June 4^th and then another eight weeks until the July 30th decision with forecasts. Time will test their very guarded bias. The questions will become more complex by those next two meetings by encapsulating post-election domestic policies.

The statement is here and see the appendix for a statement comparison. The full Monetary Policy Report is here, but with the promised scenarios and no central base case. The Governor’s opening remarks to his press conference are here. There was no accompanying research note on the neutral rate that they left unchanged at 2.25–3.25%. The press conference transcript is provided in rough form below.

SCENARIOS — BAD, REAL BAD, AND MAYBE SOMETHING ALTOGETHER DIFFERENT!

The BoC provided no central base case projection and instead provided two scenarios for growth and inflation as shown in charts 1 and 2 compared to our own current projections. The BoC also emphasized that there are other potential scenarios which is to be expected.

Definitions of scenarios 1 and 2 are captured in a moment, but what I’m unsure about is the Governor’s assertion that we have “moved trade policy back towards the middle of the two scenarios.” Yesterday’s and this morning’s announcements on tariffs from the US, plus the EU’s guidance, and also China’s high bar for conditions to even talk to the US, all lean back somewhat closer to scenario 2 in my view which adds inflation risk including through disrupted supply chains. Of course, the BoC—like ourselves—struggles with rapidly shifting assumptions by an erratic US administration.

I also like a view that leans toward high tension until we get closer to midterm election campaigning later this year into early next. If the GOP goes into midterms with this kind of trade policy, then in my opinion they could easily lose one or both chambers of Congress.

Scenario 1 assumes tariffs get negotiated away but along an unpredictable process marked by continued caution. Scenario 2 is a long-lasting global trade war with ‘severe’ economic consequences.

WHAT WASN’T ASKED BUT WILL BE IN JUNE AND JULY

By that decision, the BoC will be forced to address what nobody asked in the press conference today: what about the effects of Canadian policy developments out of the election? With the election on April 28th and stark differences in the orientations of the two main parties there could be material effects to incorporate either by June 7th, or, more likely, by the July 30th MPR decision by which point we are very likely to have a Federal budget introduced and presumably passed. Of course, we’ll also probably have a lot more information on erratic US trade and other policies by then—and the effects.

This is where the difference between the public communications of a central bank differ from the street’s economists and markets. We can’t afford to say we won’t incorporate any assumptions on Canadian policy until we see it all passed. Expectations have to be formed and incorporated and those expectations include fiscal stimulus doing some of the BoC’s work for them on risks to growth. What the BoC also needs to be careful about in addition to trade wars is not combining an overshoot on fiscal and monetary policy like the last time.

Because of at least nearer term upside risk to inflation and the likelihood that fiscal supports intensify, our current view is that the BoC is likely to remain on hold throughout the year.

PRESS CONFERENCE TRANSCRIPT

Q1. Why wouldn't you cut today given some of the downcast numbers you presented such as the 7% drop in real estate activity and slowing business investment and household spending.

A1. The Canadian economy is starting from a good place, there is a lot of uncertainty and we are treading carefully. We reduced interest rates substantially. In March we said we would be less forward looking and proceed carefully. A lot has happened in the last five weeks but really the situation is no clearer. [ed. the starting point relative to neutral is key. The BoC has more optionality than for other central banks].

Q2. Are you more worried about upside or downside pressures on inflation?

A2. Our target is 2% inflation and we think about that symmetrically. We're very focused upon assessing both the downward pressures on inflation from a weaker economy and the upward pressures from higher costs and tariffs. We're going to do as much as we can in supporting the economy while maintaining our focus on price stability.

Q3. You say you are prepared to act decisively. Does that mean the potential for a larger than 25bps cut and/or an intermeeting cut?

A3. Acting decisively is not a code word for anything. If the situation becomes clearer, we can be more forward looking. We can go back to a base case projection and craft monetary policy around this base case. The message here is we have to be flexible and adaptable.

Q4. Do you think the role of the US as a trusted trading partner and the role of the USD as a reserve currency are becoming called into question?

A4. Rogers noting market volatility. It's premature to read anything structural into what we are seeing in terms of the USD. We did see some unusual moves in US yields but they've settled down since then. Macklem then said that next week's Washington meetings will probably focus on this.

Q5. Does your cap on inflation projections around 3% in one scenario give you more flexiblity to cut later? [ed. unsure of exact question, feeds switched]

A5. There is uncertainty about the scenarios but also about the impacts. We have not had anything like scenario 2, unprecedented in more than 100 years. In scenario 2 the economy is in a year-long recession as inflation rises but then comes back down. We're going to be assessing those upward and downward pressures and doing our best to support the economy while maintaining our primary focus on price stability.

Q6. Are you open to a 50bps cut at a future meeting?

A6. We're deliberately not giving any forward guidance. There is a lot of uncertainty about tariffs, there are opposing forces on inflation, we're starting close to 2% inflation, our interest rate is right in the middle zone, and we're going to have to be flexible and adaptable moving forward.

Q7. Have financial stability risks gone up?

A7. Rogers saying we didn't see market dysfunction. Liquidity was impaired, spreads widened in response to an abrupt policy shift in a short period of time. Just as the economy came into this in a good place, our financial institutions did likewise. They are well capitalized and have room to absorb this volatility.

Q8. How should we think about a deep recession and what would you do in that scenario?

A8. Macklem basically going over the range of uncertainties in terms of how bad things could get. Emphasizing that this could all blow over, or get very bad and "we'll see". In terms of the policy response, if things break clearly in one direction, we're prepared to act decisively.

Q9. Should we discount economists that present point estimates? Are you worried that your sccenarios and uncertainty could add to Canadians' anxiety?

A9. I think the key is not to offer false precision. There is a broad range of forecasts out there. The broad range of forecasts reflect very different assumptions about what happens to US trade policy. Anybody using these forecasts needs to be thinking there is a range of possible outcomes here.

Q10. How long would inflation need to stay above 3% in a recession scenario to not be considered temporary? Are we talking months or quarters?

A10. We want to ensure Canadians do not lose confidence in price stability. The inflation outcomes can be very different. Canadians are facing high enough uncertainty and we don't want them to worry about price stability on top of that.

Q11. Is there a way of getting rid of this uncertainty in terms of what the BoC can do?

A11. Unfortunately there is nothing we can do about US trade policy. We can assess the impact of tariffs and uncertainty on the economy. First, we're using our economic models with different tariff scenarios to understand the channels and magnitudes of how they will affect the economy. Second, we are doing more work through our regional offices to reach out to businesses and consumers on the effects. Third, we are assessing data including prospective indicators like financial markets and confidence gauges and to a limited extent in some recent data.

Q12. How is the BoC thinking about housing at this point?

A12. Rogers answered. We've seen a big drop in housing activity in the Toronto area. There is more supply coming on in purpose-built rentals and condos. There is a chance in immigration policy. And Toronto is getting hit more than others by the uncertainty around US trade. Housing has been overtaken by trade policy now.

Q13. Economists and markets were predicting a coin toss chance of a cut or hold today. If you could comment how close a call was today's decision?

A13. Macklem answering. We did consider cutting 25bps. The last time we considered cutting but without clarity on tariffs we decided to wait. Then Rogers answered. We always start off with a range of views. Some of us are more optimistic that the effects won't be really really big and that's where a lot of the discussion centered this time but it is hard to have conviction on the growth and inflation risks. But there was a clear consensus on the decision to hold.

Q14. Compared to other central bank decisions is Canada faring better such as relative to the BoJ?

A14. Unlike most other countries the US has imposed universal tariffs twice and retracted twice but we do have tariffs on some very important parts of our industry. Our economy is so integrated with the US and the impacts are particularly strong. Key is what happens to the US economy. These US tariffs are not good for the US economy and in scenario 2 the US economy goes into recession which will further reduce demand for Canadian goods and services.