Bank of Canada keeps rates on hold but expects GDP hit from wildfires

Raffi Boyadjian, XM Investment Research Desk

The Bank of Canada kept its overnight rate target unchanged at 0.5% today at its May policy meeting in a widely expected move. The Bank has held rates at 0.5% since July 2015 even though Canada’s economy has been struggling to adjust to the collapse in oil prices.

The Canadian economy, which was among the few advanced economies to escape the global financial crisis of 2008 mostly unscathed, has been hit hard by the plunge in crude oil prices. The country suffered a mild recession in the first half of 2015 as lower oil revenues started to bite. However, a weaker Canadian dollar helped a rebound in non-energy exports, pulling the economy back to growth in the third quarter of last year.

The US dollar surged by around 38% against its Canadian counterpart between mid-2014 and its peak in January 2016 as oil prices tumbled. But the recovery in oil prices since then led to a 10% correction in the USD/CAD pair between January and early May, before rebounding somewhat in mid-May. The stronger loonie is likely to negatively impact first quarter growth.

This is already evident in the monthly GDP figures where GDP growth between January and February turned negative for the first time since September 2015. Second quarter growth is not looking too optimistic either as the wildfires in Canada’s oil sands region in Alberta could cost the economy up to CA$ 1 billion.

It is estimated that the wildfires that broke out on May 1 amounted to lost output of 1.2 million barrels of oil a day during the two-week period that supply was disrupted. The Bank of Canada had in April upgraded its growth forecast for 2016 from 1.4% to 1.7%. This now looks difficult to achieve given the impact and cost to the economy of the wildfires outbreak. In the accompanying statement from today’s policy meeting, the Bank of Canada said the wildfires could shave 1.25% from GDP growth in the second quarter.

However, the Bank expects for the economy to rebound in the third quarter “as oil output resumes and reconstruction begins”. The rebuilding effort in the areas affected by the wildfires could add around CA$ 1.3 billion to Alberta’s economy according to the Conference Board of Canada. The recently announced fiscal stimulus package by the Canadian government, which includes increased spending on infrastructure projects and tax breaks, should also boost growth.

The Canadian dollar jumped to a one-week high of 1.3125 per US dollar after the decision as investors were expecting a more dovish statement by the Bank of Canada. There was little to indicate in the statement though that the Bank is maintaining an easing bias, describing the risks to its inflation projection as “roughly balanced”. The Bank’s neutral stance on rates will likely mean that US monetary policy and crude oil prices will be the main drivers of the loonie in the coming months.