Bank of Canada Holds Tight on Household Debt, Nafta Concerns -- 2nd Update

The Bank of Canada on Wednesday left its policy interest rate unchanged at 1% after increases in July and September, and signaled its intent to hold steady until it gets a firmer grip on how indebted households respond to higher rates.

The bank also indicated it is waiting to get a better view of the Trump administration's trade policy.

"While less monetary policy stimulus will likely be required over time, the governing council will be cautious in making future adjustments to the policy rate," the central bank said in a statement explaining its decision to hit pause on rate increases.

At a press conference, central-bank Gov. Stephen Poloz said the record debt Canadian households are carrying means they are now more sensitive to any change in interest rates. He said he also is watching reaction to tougher mortgage-financing rules unveiled this month by Canada's banking regulator, which are expected to weigh on real-estate activity.

"There's nothing automatic," Mr. Poloz told reporters in the Canadian capital, "only a clear assessment that over time [if] the economy continues to behave as it has, less monetary stimulus will be needed."

Mr. Poloz's wait-and-see approach "signals unease toward rushing any further tightening any time soon," said Derek Holt, economist at Bank of Nova Scotia.

It was less than two months ago that the Bank of Canada raised rates for a second time this year on the belief the economy had become more broad-based and self-sustaining.

Forecasters and traders were quick to revisit their outlooks after Wednesday's statement.

The Canadian dollar fell Wednesday to a three-month low, losing more than a cent against its U.S. counterpart following Mr. Poloz's press conference. The U.S. dollar was recently at C$1.2817, from C$1.2676 late Tuesday, according to data provider CQG. Moreover, the probability of a December rate increase dropped from 50% earlier in the week to about a third in the overnight-index swap market, Mr. Holt said.

Many economists now say the next move up in rates from the BOC won't unfold until next year -- and that may be conditional on the outcome of talks to revamp the North American Free Trade Agreement. Nafta talks won't resume until mid-November after the latest round turned contentious among U.S., Canadian and Mexican officials.

The Bank of Canada identified growing protectionism under the Trump administration as one of the "substantial" uncertainties surrounding its outlook.

"We simply don't know enough of what may happen," Mr. Poloz said.

The Canadian central banker added that conversations with firms indicate some are contemplating moving production capacity offshore as a hedge against further action from the Trump White House.

"Those are options firms have in front of them," Mr. Poloz said, adding its outlook incorporates slower growth in business investment due to Nafta's uncertain fate.

Despite signs of caution, the central bank said the economy is operating close to capacity. In theory, an economy that is moving toward full capacity will experience increased demand. That, in turn, should put pressure on input costs, such as wages, and inflation.

The Bank of Canada, though, said recent strength in the Canadian currency -- coinciding with the bank's shift toward tightening financial conditions -- means exports will accelerate at a slower-than-expected pace, and the annual inflation rate won't hit 2% until the second half of next year. The central bank sets rate policy to hit and maintain 2% inflation.

The central bank added that modest wage gains and a below-average level of hours worked suggest there is still "some excess capacity" in the labor market, adding the recent decline in the jobless rate to a postcrisis low "likely overstates the degree of improvement" in the jobs market.

David Madani, economist at forecasting firm Capital Economics, said overall, Bank of Canada officials remain positive on the economic outlook but "aren't as sure as before," due to Nafta, domestic housing risks and Canadians' debt profile.

The decision comes amid a string of economic data that indicate Canadian economic activity has slowed after a stellar run in which the economy grew 3.7% in the 12 months to the end of the second quarter. The BOC now forecasts gross domestic product will grow just 1.8% annualized in the third quarter, after a 4.5% jump in the previous quarter. Annualized growth should pick up to 2.5% in the final three months of the year.

The central bank said 2017 growth is anticipated to hit 3.1%, followed by a slower 2.1% expansion in 2018.

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

(END) Dow Jones Newswires

October 25, 2017 15:12 ET (19:12 GMT)