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BoC set to ease on Jan 20th – BofAML

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Jan 13, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    FXStreet (Delhi) – Research Team at BofAML, suggests that sinking energy prices, economic weakness, and factory-sector stagnation suggest the BoC’s forecasts are too optimistic and come January 20th, they expect the BoC to cut the overnight rate by 25bp, in response to a struggling economy.

    Key Quotes

    “The consensus expects the BoC to stay on hold. The OIS market is pricing in an ease later this year, but we don’t think the Governor will wait – monetary policy operates with lags, so a near-term cut would help ease the pain further out.

    The oil drag continues: The BoC assumed a WTI oil price of $45/bbl in their October forecast, but as this goes to print, the price of WTI oil is $33/bbl and falling. Our Commodity strategy team argues that crude oil prices could reach mid-$20/bbl in the short term given extremely high inventories. As we discussed in “WTI chronically below $35/bbl could trigger another rate ease”, existing oil sands production would begin to turn cash flow negative if energy prices remain chronically below $35/bbl. This poses a substantial economic risk: even a moderate 10% drop in energy production would cut GDP by 0.8pp.

    BoC forecasts are too optimistic: The BoC will mark-to-market their forecasts on Jan 20th. Drags to their forecast include:

    - A lower oil price assumption (probably closer to $35/bbl instead of $45/bbl).

    - A cut to 4Q GDP growth from 1.5% to roughly -0.5% given recent data.

    - A cut to 2016 US GDP growth from 2.6% to around 2.3%, in line with our call.

    Presumably, there would be a drag on Canadian growth as a result. Thus, we think the BoC will have to cut 2016 annual GDP growth by 0.5pp to around 1.5%. This would push back the closing of the output gap by roughly a year. In our view, this is a shock substantial enough to warrant another ease.

    Where could we be wrong?

    Although we expect a cut at the January meeting, there are a few reasons why we could be wrong. Firstly, Governor Poloz has been reluctant to admit that the economy has deteriorated. This could suggest a bias for holding rates steady. Second, the BoC has not yet fully accounted for the economic “boost” from the Federal infrastructure plan. We expect those edits to come only with the April MPR (post budget) and we see only around 0.2pp of upside to GDP growth in 2016. In our view, financial stability concerns are less pressing than before, as the new government has shown that they are willing to implement macroprudential steps to keep housing excess at bay.”
    For more information, read our latest forex news.

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