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Canada’s Interest Rate Hikes in 2019

BoC

For the moment, Canada’s economy continues to gain the rewards of strong U.S. activity and should see a reputable 2.5% growth rate overall for 2018. Moreover, it could be seen that Canada will grow at a slightly slower pace in terms of growth in 2019, reflecting a more moderate expansion in the U.S.

Many Bank of Canada (BoC) policymakers will unlikely be fazed by this, although trade tensions remain a clear growth risk in 2019. It is wise to remain cautious, despite some positive headlines from the recent G20 meeting, particularly given that a lot needs to happen in the next 90 days. In fact, we have already seen markets drop due to the arrest of the daughter of the CEO of Huawei. If tensions intensify, the resulting slowdown in the U.S, which is Canada’s largest export partner, would have negative consequences for the Canadian economic story.

On another note, the "Nafta 2.0" approval should remove the grey clouds from the investment outlook but a lot depends on what happens to the United States-Mexico-Canada Agreement (USMCA), as there are a few key hurdles to overcome. There have already been some murmurs by Californian representative Nancy Pelosi (who is expected to be the elected speaker of the U.S House of Representatives) that she would like to see a better agreement on the labour and environmental issues.

Should Congressional approval be sought, the outlook for exports and investment should regain some energy next year, particularly if the fresh clarity prompts a rise in overall business confidence.

We also have seen wage growth being particularly disappointing over recent months, falling from 3.93% in May to 1.87% in October for permanent workers. Importantly though, there are signs that this could begin to improve again in 2019. The central bank’s recent Business Outlook Survey shows firms reporting production capacity constraints, which prevents them from meeting higher demand, and it is expected that this should renew pressure on wages in 2019.

At the same time, consumer confidence is in good shape and should support spending in the near term. More clarity about USMCA uncertainties should add a further boost if consumers grow more confident about the shape of the economy. That said, as higher borrowing costs continue to eat into disposable incomes, consumption could contribute less to 2019 growth, and the housing market won’t help that for two reasons.

Firstly, higher rates and tighter mortgage rules are likely to see further declines in housing resales.

Secondly, house price gains are shrinking as house prices cool. The resulting wealth effect may weigh on spending and sentiment.

Silver linings are present though. The number of high-ratio mortgages being offered has fallen, which has helped make debt levels of new homeowners more sustainable.

Near-term target inflation should keep the central bank tightening. Inflation is expected to ease towards the Bank’s 2% inflation target next year. CPI is expected to inch down to 2.1% in 2019 due to the impact of higher gasoline prices and minimum wage increases continuing to fade, alongside some downward pressure from the stronger Canadian dollar.

That being said, what really matters for the central bank is core inflation, which is likely to remain supported by solid growth and the wage outlook.

What this means for interest rates

Putting all the pieces together, two rate hikes are expected, one in the first quarter of 2019 and the other in the third quarter of 2019, taking the policy rate towards the lower end of the BoC’s estimate.

That being said, a third rate hike shouldn’t be ruled out as it all depends on the strength of wage growth and if trade tensions remain in check.

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