Interest rate hike: Why the Bank of Canada may hold off

Analysts have predicted this will be the year that the Bank of Canada raises its benchmark interest rate. And it could very well be the year it does.

Unless of course, it doesn't.

"I think it’s a stretch," says Derek Holt, vice-president of Scotiabank Economics.

"​I think we have to entertain the distinct possibility that they are on hold throughout all of 2015 and 2016."

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That's certainly not the prevalent wisdom among many experts who believe that sometime in the the third quarter, around the fall of this year, Canadians could face higher borrowing costs following a .25 or .5 hike in the benchmark rate of one per cent. And that could be followed up by a couple more moderate hikes in 2016, before the rate settles at 2.0.

The problem with those forecasts, Holt says, is that analysts have not yet factored in the collapse of oil prices. Hiking interest rates is a measure to fight inflation. But the drop in prices at the pumps and other energy related commodities would mean a drop in inflation. 

"I think this coming summer with the effects of the drop in oil prices we’ll see headlines ... 'inflation dropped down to around one per cent.' If we really do see that kind inflation picture ... then there's no way [the Bank of Canada] starts to communicate a more hawkish bias or the risk of rate hikes toward the end of this year or even 2016," Holt says.

Although the U.S Federal Reserve will likely hike its rates, it doesn't mean Canada will or must follow suit, he says.

"What we're arguing is a historically long gap between when the Fed starts to raise rates and when the Bank of Canada does, in part because our two economies are more off cycle from one another than they’ve ever been," Holt says.

May cut rates

Holt is not alone in his prediction that Bank of Canada governor Stephen Poloz may hold off. The macroeconomic research company Capital Economics predicts that not only will there be no hike, but that the Bank of Canada will actually cut rates in 2016.

The outlook for Canada's economy, according to their recent report, is "at best, mediocre" with a "significant risk that a perfect storm of a collapse in oil prices and a sharp correction in the housing market could, in a worst case scenario, trigger a recession."

At the very least, the oil prices slump and the risk of a major housing market correction will mean that the Bank of Canada will keep its rate the same for a considerable time yet, extending its longest rate pause since the 1940s, the report says.

"If we are correct, the drop in oil prices and the beginning of a potentially severe housing market slump will push the economy close to recession in 2016. Under these circumstances, we suspect that the Bank of Canada wouldn't hesitate to cut its policy rate."

Start recalculating

Holt says he believes other analysts will start recalculating some their predictions on the rate hike. 

"I think everybody's grappling with the implications of the decline in oil and what that will do to the Canadian economy and inflation projections," Holt says.  "We could see a number of revisions.

"I’d be surprised if over the course of the next few months we don’t see much more of [a] consensus."

That's entirely possible, says Benjamin Reitzes, vice-president and senior economist at Bank of Montreal Capital Markets, who says his bank may have to tweak its forecast.

"Our call at the moment is that they start raising rates in October, but I think the risk clearly is that they delay that a little bit further at this point," Reitzes says.

"There's a solid chance we'll have to push that further out if the economic data weaken." 

But TD economist Leslie Preston says her bank is still sticking to its prediction of a rate hike in October. Commodities are notoriously difficult to forecast, Preston says, and she agrees that if economists' oil price forecasts are wrong, then there is a risk the Bank of Canada would delay interest rate hikes.

But Preston says oil prices could find a bottom in the first half of the year and start gradually heading back up.

Meanwhile, Canada's economy had a fairly decent year in 2014 with around 2.4 per cent growth, she says, with forecasts for 2015 at 2.3 per cent growth. Unemployment is also expected to hold steady and Canada should benefit from the U.S. economy growing at a very strong pace.

"It's good to have disagreement," Preston says. "I find we economists here in Canada, it's frequently tough to find disagreement between the various shops. Or the disagreement is very minor."