Bank of Canada keeps rates on hold but Brexit and wildfires to weigh on growth

Raffi Boyadjian, XM Investment Research Desk

The Bank of Canada held interest rates unchanged at 0.5% at its monetary policy meeting on Wednesday as expected. However, the central bank lowered its outlook for the country’s GDP for 2016 in its latest quarterly report as second quarter growth is expected to take a big hit from the wildfires that broke out in Canada’s oil sands at the beginning of May.

The forecast for annualized growth in the second quarter was lowered sharply from +1.0% to -1.0%. The downward revision is mainly as a result of the direct impact of the wildfires, which are expected to shave 1.1% from the annualized rate. However, growth is forecast to rebound strongly in the third quarter to 3.5%, up from the central bank’s previous estimate of 2.2%, as the rebuilding of the worst hit town, Fort McMurray, gets underway and oil output recovers.

For 2016, the forecast for average growth was revised down from 1.7% to 1.3%, and for 2017, from 2.3% to 2.2%. In its quarterly Monetary Policy Report, the Bank said it expects a climate of heightened uncertainty, with Brexit being a major factor for this. According to the BoC’s estimates, Brexit could cut Canadian GDP by 0.1% and global GDP by 0.2% by the end of 2018.

Weaker-than-expected exports are also seen as weighing on growth. Export performance has been mixed with some non-energy sectors benefiting from the Canadian dollar’s past declines but other sectors struggling. Non-energy exports declined sharply in May for the third time in four months and the recent rebound in oil prices has not been enough to offset these falls. Investment was also revised lower as the global uncertainty and the reduced investment in the energy sector have taken their toll on business spending.

Inflation on the other hand was revised slightly up, from 1.4% to 1.6% in 2016, and from 1.9% to 2.1% in 2017, as a result of the higher oil prices.

There was no mention of the Canadian dollar’s recent appreciation, which is up by about 6.0% against its US counterpart so far this year. In fact, the BoC still expects to see some positive effects on exports from the loonie’s past deprecation.

The Canadian dollar firmed sharply after the BoC’s decision as many analysts were expecting an even more dovish outlook and gloomier forecasts. Some concerns in the report about fuelling house price growth in the Vancouver and Toronto areas also dampened expectations that the Bank of Canada would cut rates later this year. The central bank last cut its overnight rate target by 0.25% in July 2015. The loonie was last trading at around 1.2990 to the US dollar, having eased off from 1.2936 immediately after the BoC’s decision, but still firmer from around 1.3060 prior to the announcement.