Bank Of Canada's Dovish Message

by: Kenny Yang

Although Canada was the first G7 country to raise rates after the Great Recession, the Bank of Canada (BoC) is becoming more dovish especially after Stephen Poloz took over as Governor after Mark Carney left to run the Bank of England. The leadership change was almost similar to the ECB leadership change in 2011 where the successor was more dovish than the predecessor. Macro conditions in Canada is not showing much improvement despite the third quarter GDP reading of 2.7%. Exports and investments are weak while inflation is undershooting the bank's target.

The Dovish Message:

In a statement released after the bank's December monetary policy meeting Wednesday, it is acknowledging that inflation has moved further below the bank's target of 2% due to lower prices for energy and consumer goods. The latest CPI reading showed inflation of 0.7 year-over-year and core inflation of 1.2%.

In the October statement (see excerpt below), the bank stated that low inflation was a serious risk. However, the elevated household imbalances was a key risk as well.

Although the Bank considers the risks around its projected inflation path to be balanced, the fact that inflation has been persistently below target means that downside risks to inflation assume increasing importance. However, the Bank must also take into consideration the risk of exacerbating already-elevated household imbalances.

However, in yesterday's statement (see excerpt below), the bank indicated that deflation risks have increased while there is no new concern regarding household imbalances. Weighing the two risks, it appears the bank is more worried about deflation than the elevated household imbalances. As shown in graph 1, inflation is continuing to deviate from the bank's 2% inflation target.

The risks associated with elevated household imbalances have not materially changed, while the downside risks to inflation appear to be greater. Overall, the balance of risks remains within the zone articulated in October. Weighing these considerations, the Bank judges that the substantial monetary policy stimulus currently in place remains appropriate.

Graph 1: Inflation and Core Inflation vs. BoC's 2% Target

Source: Statistics Canada


The Bank of Canada is sending a clear message to investors that it intends to hold its key policy rate at 1% longer than the market is currently pricing. Many economists expect the bank to raise rates in late-2014. However, given its dovish message in Wednesday's statement and the fact inflation is running significantly below its 2% target, I won't be surprised if the bank waits until late 2015 to raise rates. If inflation does not pick up in the next few months, the bank might even consider cutting rates, which it has the flexibility to do so given its key rate is not at the zero bound like the Fed or ECB.

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