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MNI POST-BOC: Reinforced Confidence Tightening Warranted

By Yali N'Diaye
     OTTAWA (MNI) - While the Bank of Canada maintained the overnight rate
target unchanged at 1.25% Wednesday, as widely expected by markets, and
confirmed its "cautious" and data-dependent approach to the normalization
process, its wording showed a greater confidence in the need for that process to
continue to unfold.
     "Progress" on the inflation and wage growth fronts "reinforces" the BOC's
view "that higher interest rates will be warranted over time," the central bank
said in its statement.
     In its March 7 statement, the BOC's language about the need to further hike
rates was less assertive: "the economic outlook is expected to warrant higher
interest rates over time," it said then.
     Wednesday's statement repeated that "some monetary policy accommodation
will still be needed to keep inflation on target."
     While the BOC acknowledged the weaker-than-expected first quarter GDP
performance, which translated into a downgrade of the forecast for annualized
GDP growth to 1.3% from 2.5%, it expects a strong rebound in the second quarter
to 2.5%.
     The overall 2018 GDP estimate was thus only revised down to 2.0% from 2.2%
in January, while the 2019 estimate was revised up to 2.1% from 1.6%, before
growth slows to 1.8% in 2020. Growth estimates now include the impact of the
federal and provincial governments budgets.
     Potential growth was also revised up, to 1.8% in 2018, 2019 and 2020, from
1.4%, 1.5%, and 1.6%, respectively.
     That means growth is expected to grow at an above-potential rate through
2020, with inflation close or above the 2.0% target.
     The central bank is also confident the housing sector will rebound after a
weak performance in the first quarter, as well as exports.
     Declines in existing home sales in January and February, Governor Stephen
Poloz said, were more reflective of a timing issue, as sales were pulled forward
to the end of 2017 to avoid more stringent mortgage qualification rules starting
in last January.
     Exports, for their part, have been affected by transportation bottleneck.
     As a result, "some of the weakness in housing and exports is expected to be
unwound as 2018 progresses."
     Exports are one of the key pillars of the BOC's growth rotation scenario it
is sticking to, with investment being the other engine, while the contribution
of consumption to growth moderates.
     Like exports, investment has been "held back" by competitiveness challenges
and uncertainty about trade policies.
     That being said, "business investment should continue its recovery," the
Monetary Policy Report said, especially in services and information technology.
     Such an outlook definitely warrants higher rates, although the timing and
scope of future rate hikes remain data dependent.
     Higher investment would contribute to capacity building, which has already
made "some progress." 
     This would mean more room for growth without creating inflation pressures,
and would allow the BOC more time to further assess the economy's response to
higher rates, notably in the housing sector. 
     Also discouraging the BOC from rushing are growing trade tensions, with a
"notable shift" toward protectionism remaining the main downside risk to the
     "Trade policy is an increasingly prominent risk to the global economic
expansion," the MPR said. "U.S. tariff announcements and proposed retaliatory
actions by China raise the risk of a more pronounced shift away from a
multilateral, rules-based system."
     The BOC added that "a wide range of outcomes" remained possible for the
North American Free Trade Agreement.
     That being said, assumptions on the impact of U.S. policies and the
uncertainty that goes with them remained the same as in January, while reports
continue about a possible NAFTA deal sooner rather than later.
     The U.S. tax reform is estimated to cut the level of Canadian exports by
0.9% by the end of 2020, and the level of business investment by 2.1% over the
same horizon.
     So despite the escalating tensions that "risk undermining the global
expansion," the BOC did not change its assumptions for the impact on investment
in particular.
     Overall, Wednesday's statement and MPR showed that while the BOC will
remain cautious, it seemed to start setting the stage for a rate hike perhaps as
soon as July, depending on data, notably capacity.
--MNI Ottawa Bureau; +1 613 869-0916; email:
[TOPICS: M$C$$$,MX$$$$]

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