MNI ANALYSIS: Trade Deal A Boost To BOC As It Readies Hike

By Yali N'Diaye

     OTTAWA (MNI) - The announcement of a preliminary U.S.-Mexico-Canada trade

deal should strengthen the Bank of Canada's confidence as it prepares to hike

rates at its meeting Oct. 24, but the pace of tightening beyond will depend on

business investment, exports, and the housing market.

     After the widely-anticipated 25-basis-point hike in the overnight rate to

1.75% next week investors do not expect the next increase until March, and only

one more after that in 2019. BOC Governor Stephen Poloz says the bank will raise

interest rates towards a neutral level gradually, updating its judgment on the

basis of incoming data.

     While the trade deal reached Sept. 30 will provide support for the economy,

it could also improve its capacity to boost output without raising prices,

potentially reducing pressure on the bank to hurry towards its next rate hike,

something which is unlikely to come so long as the rate of increase in core

inflation remains close to 2%.

     Any boost for investment estimates in particular would provide more room

for the economy to grow without inflation getting out of control.

     --INVESTMENT BOOST COULD HELP CONTAIN INFLATION

     In its July Monetary Policy Report, the BOC estimated that uncertainty

around U.S. trade policy cut business investment by 2.5% through the end of

2020, and exports by 1.2%, compared to its previous estimates of reductions of

2.1% and 1.0% respectively. Some of this could be restored to the central bank's

forecasts at the upcoming meeting, although it could also deem that pent-up

demand in business investment was greater than previously thought.

     The BOC's Business Outlook Survey, conducted from Aug. 23 through Sept. 17,

showed that even as tensions between Canada and the U.S. escalated, investment

intentions improved.

     While there has been upward pressure on core inflation measures, the BOC

has attributed a rise in headline inflation above the 2.0% target to temporary

factors, including gasoline and air transport prices. Inflation fell to 2.8% in

September from 3% in July.

     Analysts surveyed by MNI expect a further decline to 2.7% in September. An

increase from August instead would present a challenge for the BOC's narrative,

as would higher oil prices.

     --TRADE DEAL IN BASE CASE

     A trade deal was included in the BOC's base case, so it should not affect

its view that growth is rotating towards business investment and exports, and

away from debt-fueled consumer spending, including home buying -- although

housing activity has shown resilience in the face of higher interest and

mortgage rates, despite a weak start of the year due to tighter underwriting

standards.

     The BOC expects GDP growth of an annualized 1.5% in the third quarter,

after a 2.9% gain in the from April to June.

     A key point of the agreement was avoiding new tariffs on the auto sector.

Nor should it meaningfully alter supply chains, despite concessions by Canada to

open up its dairy market.

     While mutual U.S. and Canadian tariffs on aluminum and steel remain in

place, the bank considers their impact on growth and inflation to be modest, so

long as they are lifted relatively soon.

     Real goods exports decreased 0.7% in August, although Statistics Canada

attributed this to the temporary impact of "atypical shutdowns" in the auto

sector, and, excluding autos and parts, real exports rose 0.2%.

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

[TOPICS: M$C$$$,MX$$$$]