BoC on wait and see mode – Rabobank

Jane Foley, Senior FX Strategist at Rabobank, suggests that without a thorough knowledge of how much the wildfires will cost in terms of GDP growth, it is impossible to judge how strong an impetus to growth the rebuild will have.

Key Quotes

“In February 2011 Christchurch New Zealand was struck by a devastating earthquake. Earlier this year the RBNZ reported that the “nominal GDP growth in Canterbury has increased from 3 percent in the year to March 2010 to 10.5 percent four years later”. After a slow start related to the pace of the insurance settlement, the local area saw strong pick up of activity leading to a tightening labour market and strong wage inflation.

It is impossible to draw many analogies between the two events – Christchurch is a University City and the earthquake damaged nearly 170,000 properties. In contrast Canada’s wildfires are currently estimated to cover an enormous 566K hectares but the number of buildings destroyed is estimated at a much smaller 2,400. Also Alberta oil supply is currently expected to be able to recover quickly once workers can safely return. That said, while in economic terms the scale of these two events is very different, it is still possible that the boost to growth from the post fire rebuild will iron out any need for the BoC to respond with an interest rate cut.

Although last week’s steady policy announcement was in line with the printed market median, the lurch lower by USD/CAD on the BoC’s policy announcement does suggest that some were expecting a more dovish tone in the accompanying statement.

Another factor which argues against further BoC policy easing is the level of household debt. In this week’s press release the Bank stated that “household vulnerabilities have moved higher”. In its last statement on April 13 the Bank had used more subtle language suggesting that “financial vulnerabilities continue to edge higher”. According to StatsCan, in 1980 the ratio of household debt to personal disposable income was 66%, in the final quarter of last year this had soared to 165.4%. Macro prudential measures are in place to contain the build-up of mortgage debt, but the BoC is likely to be reluctant to add fuel to the fire with another rate cut.

Looking forward, we expect the BoC to leave rates on hold at 0.5% until at least H2 2017. By contrast we expect another hike in the Fed funds rate this summer. The contrast in short-term rates should leave USD/CAD well supported. For now we are looking for widening interest rate differentials to pull USD/CAD towards 1.33 by year end and for the CAD to recover ground vs the USD into next year. That said, as in the latter half of 2014, a strengthening USD is likely to drag the CAD higher vs. many other G10 currencies. Since a boost to growth from the Alberta rebuild would also heighten the resilience of the CAD in Q3 and beyond, we expect CAD/NOK to move towards 6.56 on a 12 mth view.”