Canada: Downside risks to the economy seem manageable – NBF

“With the output gap now closed, it’s no wonder inflation pressures are rising in Canada“ said analyst at the National Bank of Canada. They point out that wages are also growing at the fastest pace since 2012, suggesting further price pressures down the line. They see the Bank of Canada to resume interest rate hikes in July.

Key Quotes:

“Canada’s GDP expanded at an annualized pace of 1.3% in the first quarter of 2018 as domestic demand provided more than an offset to an expected drag from trade, the latter due to surging imports. While consumption growth was the weakest in years, courtesy of weak real disposable income, the domestic economy nonetheless found support from government spending and business investment. Nominal GDP grew for a ninth consecutive quarter, which will pad government coffers further. A decent handoff from March ─ real GDP grew 0.3% unannualized in that month ─ warrants optimism for Q2 as well.”

“With the disappearance of economic slack and mounting inflation pressures, one could have expected the Bank of Canada to tighten monetary policy faster than it actually did. The BoC has highlighted uncertainties with regards to trade, housing and household sensitivity to higher interest rates to explain its ultra-cautious approach.”

“Concerns about housing are also warranted after earlier price surges and rising interest rates caused affordability to worsen. Tougher macro-prudential measures imposed by OSFI earlier this year are not helping either. So, the ongoing housing market correction should not be surprising.”

“All told, downside risks to the economy seem to be manageable at this point. Even amidst ongoing uncertainties, an argument could be made that real interest rates should not be negative at this stage of the economic cycle. As such, we expect the central bank to resume interest rate hikes in July.”