Bank of Canada poised for first rate cut since 2015

Supply and demand shock

It is now increasingly clear that the impact of the coronavirus will be a major drag on global economies, with Canadian activity particularly depressed by supply chain disruption from factory closures in China. While there is a legitimate argument to make that the virus represents a supply shock, it seems obvious that exports will be hurt by weaker demand from the region. A demand shock should also be felt with consumers and businesses changing their behaviour.

With Canadian GDP growth already slowing in the final quarter of last year, it is highly likely that the output gap will widen materially, as the shock effect of COVID-19 hits. In turn, we should see renewed downward pressure on inflation as growing spare capacity starts to bite.

Plunging equities and bond yields also means the economy is facing a financial shock. Oil prices are down almost 25% from earlier in the month and this all represents a serious hit to the Canadian outlook. There have also been multiple pipeline protests that had ground rail transport to a halt, which have not been accounted for in the data.

Capacity to surprise?

The bank does have a reputation of being prepared to act before risks materialise. For example, in his first policy move, Governor Poloz unexpectedly cut rates in January 2015 to counter the impact of collapsing oil prices. That said, this meeting comes without the broader analysis included in a Monetary Policy Report and Poloz has only moved rates once before in a non-MPR meeting. In addition, and to an extent, lower market-determined yields and the weaker exchange rate are providing some accommodation already.

CAD only to rise with better sentiment

Markets are fully expecting a cut of at least 25bps on Wednesday, while investors had placed odds of more than 30% yesterday for a 50bp move. This will still leave Canada with the highest rates in the G10.

CAD’s status as a high yielder will remain, which means while risk appetite and crude prices are weak, and equity market volatility is elevated, the loonie has little chance of rebounding in the short run. This week’s OPEC+ meeting will also be another challenge, given markets expectations in terms of production cuts.

However, the CAD sell-off is looking stretched and there are hopes that the G7 finance minister’s announcement later today may soften contagion fears.