MNI BOC State of Play: Not Too Quick, Not Too Slow

By Yali N'Diaye

     OTTAWA (MNI) - Caught between increased uncertainty related to U.S. trade

policies and the renegotiations of the North American Trade Agreement and a

domestic economy already growing close to full capacity, the Bank of Canada took

the middle of the tightening road Wednesday, delivering a widely expected rate

hike and signaling that a "mechanical" approach would not be appropriate going

forward.

     --FULLY DATA DEPENDENT

     This will translate in a BOC that remains "cautious" and data dependent.

     The central bank raised its overnight rate target by 25 basis points to

1.25%, signaling more hikes "over time" but also "some continued monetary policy

accommodation."

     In light of uncertainty clouding the outlook, Governor Carolyn Wilkins told

a press conference that "raising the policy rate too quickly would risk stalling

the expansion, and cause inflation to fall back below target."

     "At the same time, raising the policy rate too slowly would risk a buildup

of inflation pressures," Wilkins said.

     Governor Stephen Poloz added the central bank remains "fully data

dependent," and welcomed the market's own interpretation of the data.

Wednesday's rate hike, as a result, was a validation of the market's

interpretation.

     --EYES ON CAPACITY

     At this stage, with the economy running close to capacity, the central bank

said the evolution of growth potential is a "key issue", pointing out some early

indication that growth potential could indeed be increased, which would create

"room for more non-inflationary expansion."

     "Capital investment, firm creation, labor force participation, and hours

worked are all showing promising signs," the statement said. If confirmed, that

would allow the BOC to slow down the pace of normalization.

     To that effect, the next update of growth potential in April will be

particularly important. Currently, the BOC estimates the potential between 1.1%

and 1.7% for 2018 and 1.1% to 1.9% for 2019.

     The BOC might also keep a close eye on the spread between benchmark world

and Canadian oil prices, the sharp widening of which has "diluted" the benefit

of higher commodity prices for Canada.

     The BOC said transportation constraints faced by Canadian producers were

partly to blame for the widening of the spread between the prices of the West

Texas Intermediate (WTI) and Western Canada Select (WCS). The lack of capacity

to ship Canadian oil in a cost effective could be in part explained by temporary

outages.

     So if transportation issues are resolved, the price of WCS could move

closer to that of WTI, the BOC said, while risks to global oil prices are tilted

to the downside.

     --THE NAFTA CLOUD

     The "very big unknown", however, remains U.S. trade policy, with the BOC

particularly watching business investment, the key transmission channel of

NAFTA-related uncertainty.

     Poloz declined to say whether a withdrawal of the U.S. from NAFTA would, in

and of itself, be a shock big enough to end the tightening process in the

current economic environment.

     The BOC estimates that trade-related uncertainty will reduce the level of

investment by about 2% by the end of 2019, representing an additional drag of

0.5 percentage points compared to October, or 0.3 in GDP terms.

     Companies are also assessing their investment decisions in light of the

U.S. tax cuts, which could subtract 0.5% from the level of Canadian investment

by the end of 2019.

     Analysts are also watching the Federal Reserve policy as a source of

influence of the BOC's decisions given that the U.S. and Canadian economic

cycles are now more synchoronized.

     However, Poloz said the more synchronized cycle was not making the BOC's

policy more tied to the Fed's.

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

[TOPICS: M$C$$$]