Bank of Canada holds rate, Oct cut unlikely

The door's been left open for rate cuts, but it seems unlikely in the immediate term

Ruth Saldanha 4 September, 2019 | 12:49AM

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The Bank of Canada left interest rates unchanged today, at 1.75%, contrary to the global doveish trend that has seen other central banks, including the U.S. Federal Reserve, cut rates.

“In Canada, growth in the second quarter was strong and exceeded the Bank’s July expectation, although some of this strength is expected to be temporary. The rebound was driven by stronger energy production and robust export growth, both recovering from very weak performance in the first quarter,” the Bank said in a statement. However, it also warned that it expects economic activity to slow in the second half of the year.

The move was largely expected, with most Bay Street experts believing that while rates would be unchanged in this announcement, the Bank of Canada Governor Stephen Poloz would set the stage for a cut in October. However, the statement was more neutral than doveish, and an October rate cut is not quite guaranteed anymore.

“The Bank of Canada resisted the temptation to join its global peers, and was non-committal on future cuts, opting for a wait and watch approach. The chances of an October cut have gone from 65% to 45% on the street,” said Candice Bangsund, vice president and portfolio manager at Fiera Capital.

RBC chief economist Josh Nye pointed out that an economy that is operating close to full capacity, with inflation on target and wage growth picking up, has kept the Bank from committing to a future rate cut (or perhaps it’s Governor Poloz’s reluctance to provide any forward guidance). “Already-high household debt levels—seeing renewed focus in today’s policy statement—also arguably raise the bar for a move. Our forecast assumes a move in January. We’ve been flagging growing risk of an earlier cut, which has only been diminished slightly by today’s statement,” he said in a note.

Leith Wheeler has dropped its probability of a rate cut in October to 25%, but has fully priced in a cut by March 2020, vice president and portfolio manager Catherine Heath said.

An October cut still on the cards?

BMO believes the Bank could cut next month. “The rate has been pegged at this level since last October, but the tone of the statement left the Bank with the option to trim this October,” BMO chief economist Douglas Porter said in a note, adding that on balance though the Bank is not committing to anything, the remarks are still in tune with his revised call of a 25 bp rate trim at the October 30 meeting.

Porter pointed out that policymakers have another eight full weeks before the next decision, including two full months of jobs and CPI releases, and (likely) another Fed rate cut, and even a Federal election in the meantime. “Clearly, much will ultimately depend heavily on how the US/China trade war plays out; but, given that we are not optimistic on that front, we lean to a rate cut in late October”.

CIBC economist Avery Shenfeld believes the bank drafted a statement designed to give them some time to think about what to do next, rather than dropping a clear hint of an October cut. “The final paragraph, where the policy decision is summarized, had an on-the-one-hand, on-the-other-hand tone. Not quite as dovish as the market was expecting, and that will have the Canadian dollar a bit stronger and likely see the bond market reduce the implicit odds of an October cut. We do think the Bank of Canada will ultimately have to ease, but perhaps December is looking more likely than October for that decision,” he pointed out in a note.

What should you do?

There’s no consensus on when the rates will be cut, exactly, but there is the growing feeling that the Bank could cut by next year. So how should you play the market? Our view at Morningstar is that investors should focus on long-term financial goals, and invest accordingly, and therefore should not pay attention to daily or weekly market events.

However, if you do want to invest right now, Bangsund believes that over the short- to medium- term, defensive plays will reverse, and cyclical sectors will recover.

“We primarily like energy, industrials, metals and financial services. These sectors account for 2/3rd of the S&P/TSX Composite index, and as a result, we are overweight Canadian equities, and underweight fixed income right now,” she says.

For investors who want to stay in fixed income, Heath sees opportunities in Canadian corporate debt. “The corporate credit curve is positively valued right now, and we see some opportunities in corporate debt. Having said that, retail investors might find it hard to evaluate individual opportunities, so the best way to play this theme is to consider a fund,” she said.

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Ruth Saldanha  Ruth Saldanha is Senior Editor at Morningstar.ca