As PIMCO expected, the Bank of Canada (BOC) cut the overnight lending rate by 0.25% to 0.50%, the second rate cut this year. Our baseline forecast is that this will be the last rate cut for 2015.
This forecast is based on PIMCO’s view that oil prices will end the year about $5–$10 higher than they are today (we expect WTI in the $55–$60 range). We also see the U.S. economy recovering from its weak start to the year and for growth over the next 12 months to average around 2.5%–3.0% real. This should translate into badly needed export growth for Canada. The latest BOC GDP forecast reduced the net exports contribution to GDP by 0.8%; we think this might be a bit too conservative. The key thing to watch is non-energy exports, which have disappointed so far this year. We think a stronger U.S. economy and a weaker Canadian dollar should eventually contribute to higher export growth.
The other key part of the economy to watch is business fixed investment, which the Bank of Canada also downgraded in its latest forecast. Clearly, the capex reduction in the oil sector has been the main negative shock. If we start to get a pickup in non-energy exports to the U.S., an uptick in capex in these sectors could also provide a small upside surprise to Canadian growth.
Finally, two big concerns are potential bubbles in housing and consumer debt. While we think these are concerns that will play out over the secular horizon, with interest rates this low, they should not be a concern in 2015.