MNI: Analysts See BOC Key Rate End 2018 At Up to 1.75%

--Terminal Policy Rate At Least 2.0% in Current Cycle 

--Hikes Could Stop On NAFTA, Accelerate On Stronger Than Expected Inflation, GDP

By Yali N'Diaye

     OTTAWA (MNI) - As analysts surveyed by MNI look into 2018 and the outlook

for monetary policy, most see the key Bank of Canada policy rate ending next

year at 1.75%, after ending 2017 at 1.0%, where it stands now, implying no rate

hike at the December 6 meeting.

     They see the terminal rate at 2.0% at least, except for one analyst seeing

it at 1.0% maximum as a result of a housing correction.

     After the pause expected in December, that would leave the overnight rate

target at 1.0%, the BOC is seen resuming its normalization process next year, if

not in the first quarter, then in April.

     That is, unless the North American Free Trade Agreement currently being

negotiated falls apart, which was cited as the main reason by most economists to

pause the tightening process. 

     On the other hand, a stronger-than-expected inflation and GDP growth

outcome could lead to a more aggressive tightening. 

     Currently, the BOC expects Canadian growth to slow in the second half of

2017, for an annual growth of 3.1% this year, slowing to 2.1% in 2018, and 1.5%

in 2019. Inflation is expected to reach the 2% mid-range target in the middle of

2018.

     "Stronger domestic growth, the elimination of slack in the labor market,

acceleration of inflation" would all support a more aggressive BOC policy, IHS

Markit Senior Economist Chulwoo Hong told MNI, while greater uncertainty

associated with NAFTA renegotiations would slow or stop the tightening process.

     Hong's outlook is among the most hawkish.

     He sees a rate hike as possible in January 2018, although this would be the

earliest, with the BOC bringing the overnight rate target to 1.75% at the end of

2018, in line with several other analysts' forecasts.

     From there, however, there would still be room for 125 basis points of rate

hikes to Hong's estimated terminal rate of 3.0%.

     In an article of the BOC Review Thursday, BOC staff wrote that "over the

medium term, the global neutral rate is likely to remain low." They confirmed

the neutral rate - when output is at potential and inflation at the 2% target -

for Canada is 2.5% to 3.5%, meaning the real policy rate is 0.5% to 1.5%.

     In this range, the authors estimated that the probability of being at the

effective lower bound - the lowest point the nominal policy rate can go - is in

a range of 5.8% to 11.9%.

     In countries like Canada and the U.S., "real policy rates are expected to

converge to their respective neutral rates of interest once all cyclical

headwinds have dissipated," the BOC economists predicted.

     At BMO and RBC, the terminal policy rate in the current cycle is estimated

at 2.75%. Economists at both banks expect the policy rate to end 2018 at 1.75%,

with the next rate hike in March for BMO and in April for RBC.

     BMO Capital Markets Canadian Rates and Macro Strategist Benjamin Reitze

told MNI an acceleration in inflation would be the key factor that would prompt

a more aggressive tightening, while factors that could slow the process are just

"too many to isolate one."

     For RBC Economist Josh Nye, however, trade disruptions related to NAFTA

renegotiations are clearly one factor that could slow the normalization process.

"If we don't see inflation and wage growth at least gradually picking up over

the next year the BOC would likely be slower in removing accommodation," Rye

told MNI. Should they accelerate, or should GDP grow "strongly above trend", on

the other hand, pushing the economy beyond its long-term capacity limits, rate

hikes could happen faster.

     For Action Economics and CIBC, the terminal rate could be somewhere between

2.0% and 2.50%. For the former, the next rate hike would be in March, before

rising to 1.75% at the end of 2018, while CIBC expects the current pause to last

until April, with the policy rate ending 2018 at 1.50%.

     Action Economics economist Ryan Brecht and CIBC economist Nick Exharos both

cited NAFTA as a potential slowing factor, which could persistently slow related

business investment and export recovery. 

     "Also, if the slump in exports were to continue well into next year, that

would presumably give the BOC pause," Brecht said, while a faster-than-expected

GDP growth would accelerate the tightening.

     In addition, "how our economy deals with a higher interest rates in the

consumer sector" will also play a role, Exharos told MNI.

     In its October 25 policy statement, the BOC indeed said, it "will be guided

by incoming data to assess the sensitivity of the economy to interest rates, the

evolution of economic capacity, and the dynamics of both wage growth and

inflation."

     For Capital Economics Senior Canada Economist David Madani, that

sensitivity to higher rates, combined with tighter macro prudential rules,

including the expansion of stress tests to borrowers with a down payment of 20%

who do not require mortgage insurance, will ultimately translate into a housing

correction.

     Eventually, the damage to the economy will force the BOC to not only pause

through the first half of 2018, but to cut rates by a cumulative 50 basis points

in the second half to end 2018 at 0.50%.

     In fact, Madani told MNI, the terminal rate of the current cycle is

actually 1.0% maximum.

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

[TOPICS: M$C$$$]