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MNI POLICY:Post NAFTA Deal,Data To Determine Pace of BOC Hikes

By Yali N'Diaye
     OTTAWA (MNI) - Now that Canada, the United States and Mexico have reached a
trilateral free trade agreement in principle, uncertainty about business
investment in Canada is greatly reduced, but whether it will translate into a
faster pace of rate hikes by the Bank of Canada will remain highly data
dependent, perhaps even more so.
     While more likely, a faster normalization process is not a done deal,
especially since the Bank of Canada's own projections did not assume a
termination of the North American Free Trade Agreement, and the three countries
legislatures have yet to ratify the deal. 
     First of all, details of the new agreement in principle have yet to be
clearly laid out, and while the degree of uncertainty is greatly diminished by
the simple fact that there is an agreement, many issues remain unsolved.
     The new trade agreement - renamed USMCA - is reportedly not addressing the
steel and aluminum tariffs issue. The BOC, in its July Monetary Policy Report,
had factored in a "modest" effect on Canadian growth and inflation from the
mutual tariffs.
     But how long such tariffs will remain in place could potentially increase
their impact.
     In addition, U.S. tariffs on Canadian auto imports, a much bigger threat to
the Canadian economy, remain a possibility under the new agreement.
     The new deal would indeed reportedly allow a higher number of
Canadian-produced cars into the U.S. tariffs-free, but the U.S. could still
impose duties on any amount exceeding that cap. Here too, details have yet to
     Already prior to the U.S. tax cuts, Canadian exporters were facing
competitiveness challenges long stressed by the BOC.
     The U.S. tax cuts have only exasperated the need for Canadian companies to
be more competitive, an issue that is not addressed by the new USMCA deal.
     In its July MPR, the BOC estimated that trade-related uncertainty would cut
business investment by 2.5% through the end of 2020 and exports by 1.2%. The
U.S. tax reform was estimated to cut business investment by 0.9% and exports by
0.4% over the same horizon. 
     The BOC has also made clear that every meeting was a blank sheet, and
Governor Stephen Poloz stressed in his Sept. 27 speech that the central bank
remained "decidedly data dependent," especially as it is still assessing the
impact on the economy of its own interest rate hikes, of tighter macro
prudential rules and of the digitalization of the economy.
     On the latter point, Poloz noted that "new digital technologies could be
giving the economy more room to grow before inflation pressures emerge," arguing
in favor of not raising rates too fast.
     However, he also warned against moving too slowly and risking letting
inflation build significant momentum.
     So far inflation has been exceeding target, but the BOC has attributed this
to transitory factors. Instead, it has been focusing on core readings very close
to 2.0%. 
     Still, core inflation has been picking up slightly over the past few
     And with the economy operating at potential for the past year, the central
bank itself has questioned whether its gradual approach was "appropriate". In
addition, the housing market has shown signs of stabilization after a difficult
start of the year.
     So although wage pressures remain lower than where they should be at this
stage of the cycle, the fact that the new trade deal reduces uncertainty overall
could further complicate the BOC's narrative of a gradual approach.
     To that effect, labor and export data to be published on Friday will
provide an important update. But even more important will be the October 15
Business Outlook Survey, after a summer survey that reflected "continued
business optimism", increasing capacity pressures and rising inflation
expectations despite NAFTA uncertainties.
--MNI Ottawa Bureau; +1 613 869-0916; email:
[TOPICS: M$C$$$]

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