Central banks of Japan and Canada join the dovish camp

The Bank of Japan has said interest rates will stay on hold at ultra-low levels until spring 2020, and it expects inflation to still be below target in 2021. Meanwhile, the Bank of Canada also kept rates unchanged, and pivoted away from its bias towards hiking by eliminating references to rates needing to return to a “neutral” range.

The two central banks follow the US Federal Reserve (Fed) and the European Central Bank (ECB) in taking a more dovish tilt to monetary policy this year amid worries over slower global growth. In March, the Fed signalled there would be no further rate rises this year, while the ECB said interest rates would remain on hold until 2020.    

Bank of Japan clarifies forward guidance as inflation target remains distant

Piya Sachdeva, Economist, says:

The main takeaway from the Bank of Japan (BoJ) meeting today was the tweak to forward guidance for future interest rates. The guidance that the BoJ would maintain extremely low levels of interest rates for an “extended period of time” has been changed to include “… at least through around spring 2020”.

As the initial forward guidance was rather vague, it is unclear whether this was merely a clarification or an explicit change of forward guidance to push out expectations of the next rate hike. Even if this was an attempt to lower the expected path of interest rates priced in markets, the next rate hike was already expected to be much later, by the end of 2024.

Moreover, the unchanged level of the Japanese yen versus the US dollar suggests this tweak did not change investors’ view on future interest rates materially. 

While the main monetary policy tools were left unchanged, the BoJ’s dovish stance was shown by its decision to loosen conditions through the relaxation of the collateral conditions for banks that use the Securities Lending Facility (SLF). In balancing the need for prolonged loose monetary policy against the obvious risks, the BoJ has clearly moved to prioritise the former, providing support to tackle the deterioration in near-term growth and inflation. 

In the accompanying quarterly Outlook Report, the BoJ’s new inflation forecast for FY2021 is 1.6% year-on-year. This suggests that the central bank itself does not believe it will achieve its 2% inflation target, which raises serious long-term questions over the validity of the target. 

Our view is that the BoJ will remain dovish, keeping rates on hold and continuing its asset purchases programme well beyond its forward guidance timetable. Our forecast only has one 10 basis point (bps) rate hike at the end of 2020. However, the perpetual weakness in growth and inflation means the risks are skewed to rates remaining unchanged.

Bank of Canada removes its bias towards hiking 

Irene Lauro, Economist, says:

On Wednesday, the Bank of Canada (BoC) left the policy rate on hold at 1.75% as markets expected. In its rate decision, the BoC removed its hiking bias by eliminating the reference to the need for interest rates to return to a neutral range, which was revised down by 25bps to 2.25–3.25%.

The BoC said that an accommodative policy rate continues to be warranted as the outlook for growth for the first half of 2019 has deteriorated. Amid the 2018 crude oil price slump, ongoing oil transportation bottlenecks and trade policy uncertainty that continue to weigh on investment and trade, the bank now expects the economy to grow 1.2% in 2019, down by 0.5% from its January forecast.

However, the bank believes that the slowdown of growth to a below-potential pace will prove to be temporary, as the BoC left growth expectations for 2020 untouched at 2.1%, which is above the BoC’s estimate of potential growth of 1.8%. The bank said that it will keep watching developments in household spending, oil markets, and global trade policy to gauge the extent to which the factors weighing on growth and the inflation outlook are dissipating.

On the possibility of rate cuts, during the press conference Governor Poloz said that that if the BoC’s forecast is right “which I firmly believe it to be, then interest rates are more likely to go up than down over time”. While his statement suggests that the hiking cycle could resume as the economy is expected to grow above potential in 2020, a significant slowdown in the US or further weakness in global growth could trigger an even more dovish BoC shift.

The BoC is likely to stay on hold throughout this year, and as the Bank remains highly data dependent, we will need to see a substantial economic rebound in the second half of 2019 for the BoC to resume its hiking cycle next year.