BoC: Output gap on track to be closed soon - AmpGFX

The rates market is pricing the odds of a 25bp BoC hike on 12 July at 76% and the market is assigning the July meeting a high probability since it also coincides with the quarterly Monetary Policy Report, suggests analysts at Amplifying Global FX Capital.

Key Quotes

“The quarterly MPR provides an opportunity to reset forecasts and is the obvious time to recalibrate policy.  Having danced the market so close to pricing in a hike, the BoC might decide that it should get on with it, or else be accused of sending mixed signals. As such, a hike indeed appears very likely.”

“This would be part of a two-step process of unwinding the 2015 cuts, so the market is also pricing in a high probability of a follow-up hike later in the year.”

“A key point made by Senior Deputy Governor Wilkins in her 12 June speech was that the recovery in Canada was broadening across sectors and regions in the economy.  A sign, she considered, that the economy had adjusted to the reality of lower oil prices.  She said, “The data show that more than 70 per cent of industries have been expanding—a rate we have not seen since the oil price shock. That is the kind of diversity that helps support strong and sustained overall growth.”

“Governor Poloz said in his CNBC interview on Wednesday said that the adjustment to the 2014/2015 oil price shock is “largely complete” and suggested that the energy sector has stabilized and adjusted to an oil price in the $40 to $50 zone. Poloz also said that the BoC expects growth to moderate from the strong 3.7% q/q SAAR in Q1 to a more normal pace, but still above potential.”

“The April MPR projected growth would slow to 2.5% in Q2.  The long run potential growth rate is “projected to increase gradually from a trough of 1.3 per cent in 2016–17 to 1.6 per cent by 2020” (Apr-MPR). The BoC said that, “in the first quarter of 2017 [excess capacity in the economy] remains material, between 1 1/4 and 1/4 per cent.”

“It projected that the output gap would close in annual projections next year, and become positive in 2019. The recent strength in the recovery suggests that the gap may be near closed toward the end of this year.”

“Policy is considered extremely accommodative, and so the BoC may think it appropriate to remove some of that accommodation before the output gap is completely closed.  On the other hand, the very low inflation outcomes this year would suggest there is less urgency.”