Canada to Resist Fed Rate-Cut Pressure as Inflation Heats Up

By Greg Quinn

     OTTAWA (MNI) - Canadian GDP figures for April should show the first

back-to-back expansion since a soft patch late last year, making it still less

likely the Bank of Canada will take any marching orders from the Federal Reserve

when it comes to interest-rate cuts.

     Governor Stephen Poloz on Friday will see GDP figures for April expected to

show the first back-to-back expansion since a soft patch late last year. Poloz

this week may also be reading drafts of the Bank's own quarterly survey of

business executives due out later that morning. That survey may pick up glimmers

of hope on trade after the U.S. lifted steel and aluminum tariffs in May. 

Two other major headaches for Canada's embattled exporters are also fading away,

adding to recent signs that domestic demand is strong. Prime Minister Justin

Trudeau last week approved an oil pipeline expansion that will boost oil exports

by tens of billions of dollars a year, and he got rare praise from U.S.

President Donald Trump as the U.S. President urged Congress to pass a new North

American trade treaty.

     Unlike the Fed, Poloz is seeing inflation above 2%. Statistics Canada

reported last week inflation quickened to a 2.4% pace in May and average core

prices advanced the most since 2012. The BOC unlike the Fed has a single mandate

to keep inflation at 2%, but even with a dual mandate Poloz could also see wage

inflation pressure from a Canadian unemployment rate at a record low.

     Canada's gross domestic product is expected to have grew 0.2% in April

according to the MNI survey median, enough to keep the economy running at a

second-quarter annualized pace of around 2%. While monthly GDP will slow from

0.5% in March, the new figure brings growth to a more sustainable path.

     The GDP report is due at 8:30am New York time Friday, followed at 10:30am

by the BOC's Business Outlook Survey. The survey asks executives about prospects

for sales growth, new investment and hiring, and Poloz has said it's a key

source of information on the outlook.

     The economy saw another boost on Tuesday as Statistics Canada reported

wholesale sales jumped 1.7% in April, the fastest pace in more than two years

and beating the MNI economist consensus of 0.2%.

     Of course, Canada can't escape any slowdown linked to U.S. trade wars.

Three-quarters of Canada's exports go to the U.S., so if demand craters it could

hurt exporters who have often dragged down Canadian growth in recent years.

Exporters could also be hurt if global investors send Canada's dollar soaring as

they seek higher-yielding assets.

     Some investors are still betting Poloz will match a Fed cut this year. The

MNI Pinch model shows a Fed rate cut fully priced in for its July 31 decision,

and four cuts through 2020. The odds of a BOC reduction climb from 5% at the

next decision July 10 to 49% at the December meeting. 

     Still, it's rare for the BOC to loosen policy while inflation is

accelerating, as it has been for the last several months. Cutting the Bank's

1.75% target overnight rate now may also do little to boost the economy by

driving down borrowing costs. Yields on 10-year federal government bonds already

dropped to 1.45% last week, down from 1.75% a month ago, and more than a

percentage point less than where they were in mid November. Another problem with

rate cuts is they may encourage another round of speculative buying in the

Toronto and Vancouver housing markets, which Poloz has called a risk to the

financial system.

     "The Bank will be able to sit on its hands for a while. The policy rate is

believed to be below neutral, inflation is at target, and you really don't want

to reignite the housing market prematurely," CIBC economist Benjamin Tal wrote

in a research note.

     The Bank of Canada is already ahead on stimulus with the Fed, which has a

target rate in a range of 2.25-2.5%. So in the end, this may be more a case of

the Fed catching up to the BOC than Poloz needing to follow the Fed -- or Donald

Trump's Twitter feed on monetary policy.

--MNI Ottawa Bureau; +1 613-314-9647; email: greg.quinn@marketnews.com

[TOPICS: M$C$$$]