BOC State of Play: Status Quo Just Got Harder To Justify

By Yali N'Diaye

     OTTAWA (MNI) - Canada's economic performance surpassed both private-sector

analysts' expectations and the Bank of Canada's own projection for the second

quarter, making a status quo harder to explain for the "highly" data-dependent

central bank.

     Statistics Canada reported Thursday that the annualized real GDP growth

rate reached 4.5% in the second quarter after an already healthy 3.7% the

previous quarter, recording its largest gain since the third quarter 2011.

     In its July 12 Monetary Policy Report, the BOC had projected a 3.0% GDP

growth rate, expected to slow to 2.0% in the third quarter.

     Yet a 0.3% GDP growth in June as reported by Statistics Canada suggested a

stronger hand off to the third quarter than anticipated.

     Consumers have remained keen on spending in the second quarter, as

household consumption grew 1.1%, nearly the same rate as the first quarter, and

remaining the largest contributor to the 4.452% unrounded growth rate, even as

their saving rate rose to 4.6% from 4.3%.

     Data released Thursday by the Conference Board of Canada also suggested the

consumer spending slowdown might prove slower to materialize than expected by

the BOC in the third quarter.

     Despite a deterioration in current finances, consumers were more upbeat

about their future situation, lifting the consumer confidence index 8.1 points

to 121.7 in August, its highest level since November 2007.

     Along with greater optimism about future finances and job prospects,

sentiment about making major purchases also improved.

     Not to mention that average weekly earnings grew 1.8% year-over-year in

June, maintaining the range between 1.7% and 1.9% in the second quarter after

dipping to 1.0% in March.

     While consumer spending remained robust, the housing market slowdown did

materialize, as investment in residential structures fell 1.2% in the second

quarter, coinciding with the adoption of tighter macro prudential rules in

Ontario.

     Export showing was also strong, supporting the BOC's scenario of

strengthening sales abroad.

     Exports rose 2.3% in the second quarter after rising 0.4% the previous

quarter, recording the largest gain since the second quarter 2014.

     Uncertainty related to U.S. policies no doubt remains, as reminded by

recent repeated threats from U.S. President Donald Trump of terminating the

North American Free Trade Agreement with Mexico and Canada.

     Yet private-sector analysts and rating agencies mostly expect free trade

between Canada and the U.S. to be preserved.

     "We assume that NAFTA will hold together," Fitch analyst Charles Seville

has told MNI. "A Canada-US free trade agreement predates NAFTA. If the U.S. did

terminate the agreement, it would certainly be disruptive but we would expect

whatever framework replaces it largely to preserve free trade between Canada and

the U.S., as the economies are very intertwined."

     In a report in early August, Moody's assumed that the three-country

agreement would be renegotiated but not terminated. 

     Analyst William Foster told MNI that despite Trump's threats, "the most

likely outcome is still renegotiation."

     S&P Global analyst Paul Judson agreed in comments to MNI that free trade

flows are unlikely to be dramatically affected in the end despite Trump's

rhetoric.

     It is unlikely that the BOC would also take the threats at face value and

change its current wait-and-see approach until visibility about the NAFTA

negotiations clears up significantly.

     As a result, the improvement on the export front should be a positive on

net for the BOC.

     And while business investment slowed down in the second quarter, it still

grew 0.5% on the back of a 3.1% gain in the first quarter.

     Such data just made a status quo harder to justify at the September 6

meeting, especially with June GDP raising the potential of a less pronounced

slowdown in the third quarter.

     While inflation remains well below the 2.0% target, it did pick up in July

for the first time in five months. And with a central bank more forward looking,

an upward revision to growth projections potentially affecting the timing of the

closing of the output gap could translate into at least a more hawkish tone. 

     Against this backdrop, Friday's GDP data would argue in favor of removing

the other half of the 50 basis point "insurance" provided in 2015.

     The first 25 basis point of insurance was removed on July 12, when the BOC

said further action would be data dependent.

     As some analysts have pointed out, from a communication standpoint, there

is a case for waiting until October, which would allow the central bank to

better explain any move since it will release its next MPR on October 25,

followed by a press conference.

     It would also allow to better gauge the sustainability of July's inflation

pickup.

     Besides, the loonie's appreciation since early May is providing another

argument for further waiting.

--MNI Ottawa Bureau; +1 613 869-0916; email: yali.ndiaye@marketnews.com

[TOPICS: M$C$$$]