Bank of Canada Likely on Hold, With Nafta Clouding Rate Outlook

By Paul Vieira Features Dow Jones Newswires

Bank of Canada watchers unanimously believe the central bank will hit pause on Wednesday when it releases its latest policy decision and won't raise rates after two consecutive increases.

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There is also less certainty among analysts about the timing of the next rate increase in Canada due to the negative turn in talks to reshape the North American Free Trade Agreement.

Economists from 10 primary dealers of Canadian government securities participated in the The Wall Street Journal survey ahead of the Bank of Canada's rate decision Wednesday. One dealer, HSBC Bank Canada, did not take part in the Journal's survey.

Growth in Canada has slowed after a stellar one-year run. Three straight months of declines in exports and a poor showing in August retail sales has taken the shine off of 12 months of 3.7% growth as of June 30.

Bank of Canada governor Stephen Poloz has said the central bank would be in a heightened "data-dependent" mode, with particular focus on how the economy responds to two rate increases in July and September. On the sidelines of the International Monetary Fund meeting earlier this month, he reiterated his concern over slower expansion.

Nevertheless, prospects in Canada look solid. Growth is forecast at 2% annualized or above in the third and fourth quarters, which analysts expect to place upward pressure on inflation. The labor market continues to churn out new jobs, and wages are beginning to head higher. Finally, the sales outlook among firms remains robust, according to the central bank's latest survey of managers.

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Those factors "warrant at the very least a modestly hawkish tone" when the central bank issues its rate decision and updated quarterly economic outlook, said analysts at TD Securities.

Other factors, though, are clouding the outlook for Canadian rate forecasters -- chief among them the pessimistic tone now prevailing among U.S., Canadian and Mexican officials on Nafta after the latest round of talks.

The risk of Nafta talks disintegrating, and President Donald Trump making good on his threat to withdraw from the deal, has gone up appreciably since the end of negotiations on Nov. 17, said Derek Holt, economist at Bank of Nova Scotia. "What looms over data dependency, that by definition is a scorecard on the economy, is the state of Nafta negotiations, which affects the economy of tomorrow," Mr. Holt said of the central bank's outlook.

The fate of Nafta matters greatly to the Canadian economy. Trade with the U.S. accounts for a quarter of the country's economic output, and Nafta's end could cut Canada's gross domestic product by 1% over five to 10 years, according to initial estimates from BMO Capital Markets.

Five economists surveyed by the Journal said they expect the Bank of Canada to raise rates in December, although at least two of the analysts said their calls were in flux due to Nafta tensions. The other half of surveyed economists said the central bank would wait until the first half of 2018.

"The situation is extraordinarily fluid," said Doug Porter, chief economist at BMO Capital Markets, who believes the next rate increase will be in January.

Also lurking in the Canadian background is a set of changes to mortgage-financing rules.

Sebastien Lavoie, chief economist at Laurentian Bank Securities, said the measures -- which will force all potential house buyers to undertake a stress test before a mortgage can be approved -- could keep the Bank of Canada on hold through 2018, because their impact will be just as effective as rate increases in terms of cooling down housing activity -- especially in Vancouver and Toronto -- as well as consumer borrowing. Canadian household debt currently stands at record levels.

Other economists surveyed hold a similar view about how much the new rules will weigh on housing, which during the commodity-price slump was the main driver of Canadian economic growth.

Write to Paul Vieira at paul.vieira@wsj.com

(END) Dow Jones Newswires

October 24, 2017 06:58 ET (10:58 GMT)