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Briefing highlights

  • Markets expect rate hike to 1.25 per cent
  • But increase isn’t a sure thing
  • Bank of Canada has surprised before
  • Scenarios for how Canadian dollar reacts
  • What to expect in monetary policy report
  • Loonie just shy of 80.5 cents
  • Global markets mixed so far
  • New York poised for stronger open
  • What else to watch for today
  • Goldman, Bank of America hit by tax charges
  • Bitcoin tumbles to $10,000

Tossing and turning

Expect Bank of Canada governor Stephen Poloz to raise interest rates this morning only if he's been getting a good night's sleep.

If he's been tossing and turning, he may surprise the markets by waiting. In which case, the Canadian dollar will toss and turn along with him.

Markets are betting Mr. Poloz and his central bank colleagues will raise their benchmark overnight rate by one-quarter of a percentage point to 1.25 per cent, the first of up to three increases this year.

They'll also release a monetary policy report that includes updated economic projections and, no doubt, concerns about the swollen debts of Canadian households and troubled negotiations to overhaul the North American free-trade agreement.

Bank of Canada senior deputy governor Carolyn Wilkins and governor Stephen Poloz

Remember that Mr. Poloz, senior deputy governor Carolyn Wilkins and their colleagues raised the key rate twice last year, then called a pause amid uncertainties ranging from those troubled trade talks to the impact of those hikes on consumers.

Markets began betting heavily on Mr. Poloz resuming the cycle after an exceptionally strong jobs report from Statistics Canada this month and an optimistic business outlook survey from the central bank itself.

Which brings us to this morning's rate decision and whether Mr. Poloz, who recently gave a speech about the things that keep him awake at night, is sleeping easier.

The rate decision

Many observers believe recent indicators are enough to prompt an increase.

"Based on the economic environment alone, the case for higher interest rates in Canada is airtight," Bank of Nova Scotia economists said in a new outlook, adding that "insomnia should be waning."

Not only that, but the feeling seems to be that you can't sit around and wait.

"When governor Poloz delivered his mid-December speech, however, he removed NAFTA as one of his top concerns 'keeping him awake at night' and advised he'd deal with that risk if and when it became clearer, while showing an unwillingness to put monetary policy decisions on indefinite hold," said Derek Holt, Bank of Nova Scotia's head of capital markets economics.

"Every poker player plays the hand they've been dealt, not the one that might be dealt in the next round," he added.

"The broad underlying wage and price dynamics of the Canadian economy and excesses in the financial system should be the prime focus amid evidence the BoC is already behind the curve while trade policy uncertainty is expected to persist for an extended period."

Bank of America Merrill Lynch agreed.

"In our view, several conditions have been met for the BoC to continue withdrawing monetary stimulus: GDP growth above potential, the unemployment rate at its lowest level in decades, core inflation rising and the [Federal Reserve] hiking," Carlos Capistran, the bank's Canada and Mexico economist, rates strategist Ralph Axel and foreign exchange strategist Ben Randol said in their forecast.

Having said that, there are reasons why the central bank might sit it out today, nonetheless.

"If you're looking for reasons in the data for the BoC to take a pass, there are a few," said Benjamin Reitzes, Bank of Montreal's Canadian rates and macro strategist.

Among them are still-soft, though stronger, wage increases, and a Bank of Canada measure that indicates some slack still in the labour market, he noted.

"Beyond the data, and perhaps most importantly, the uncertainties around NAFTA, household debt, and new mortgage rules are big potential negatives for the outlook," Mr. Reitzes said.

"While the BoC has said they will not allow uncertainties to paralyze policy making, we'll see if their actions match their words."

Some at Scotiabank also aren't so sure.

"Our forward and options traders suggest that market price action in their products suggests less conviction and/or more uncertainty about the policy decision and its aftermath than market-implied risks suggest," said Shaun Osborne, Scotiabank's chief foreign exchange strategist, and his colleague Eric Theoret.

"From our perspective and that of the various trading desks, a more cautious approach to the immediate policy outlook is reflected in a range of factors – NAFTA risks remain significant … the immediate data run beyond the jobs numbers has been a little less impressive, the idea that the Bank of Canada "can't disappoint' market expectations is dispelled by the September rate hike (which was only around 30 per cent priced in on the day)," they added in their look at today's decision.

"Finally, bank communication has been zero since before Christmas when the governor suggested he was inclined to let the economy 'run a little hot.'"

And keep in mind that, as Royal Bank of Canada pointed out, this is a central bank that doesn't appear to have issues with what the markets expect.

"Unlike some central banks, the BoC seems to not mind surprising markets," said Elsa Lignos, RBC's global head of foreign exchange strategy in London.

"Looking at rate decisions over the last eight years, there are multiple occasions when the BoC defied expectations," she added.

"Based on the markers set out by the central bank, the case for a hike [this] week is pretty solid. But uncertainty should keep the BoC reluctant to offer forward guidance. That limits the upside to [the Canadian dollar] from a hike."

Four scenarios and a funeral

Given the run-up in the loonie in anticipation of a rate hike, here are today's four scenarios from Mr. Osborne and Mr. Theoret:

1 . A "neutral hike," meaning a quarter-point increase with "no firm indication on the follow-up." This would be "modestly positive" for the loonie, probably leaving it around its recent value.

2. A "hawkish hike," meaning a quarter-point increase, with another expected soon after, which could drive the currency up to almost 81.5 cents (U.S.).

3. A "hawkish hold," no increase but a signal that one is coming in March or April. This would be modestly negative for the Canadian dollar, but limiting the decline to just below or just above the 79-cent mark.

4. A "neutral hold" would be the "worst-case scenario" for the loonie. This would see no increase and a "boilerplate statement which leaves the timing of rate hikes uncertain going forward." In which case you could hold a funeral for the loonie – my words, not theirs – as it sinks fast to somewhere between 77.5 and 78.7 cents.

The monetary policy report

These always have interesting things to say, particularly about housing markets and household debts.

Expect more on that front today, along with new economic forecasts.

BMO's Mr. Reitzes expects the projection for economic growth in the final quarter of last year to be downgraded to between 1.5 and 2 per cent, annualized, which would put 2017 growth at 3 per cent.

"Look for Q1 to get introduced at around 2 per cent," he added.

"The [consumer price index] projections have taken on less importance since they only include headline inflation; even so, there could be some upward shift to account for the rise in oil prices. Over all, we're not expecting any forecast changes that would meaningfully impact the policy outlook."

RBC assistant chief economist Paul Ferley expects fourth-quarter growth to be pegged at an annual pace of 1.7 per cent.

"This slower growth rate mainly reflects indications that monthly GDP was disappointingly flat in October, with only a modest pick-up expected in November," Mr. Ferley said.

"Countering indications of softer near-term growth, the much stronger-than-expected December employment gain implies that household income growth would likely prevent any further slowing going into 2018."

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Stocks mixed

Investors aren't sure what to make of things this morning after Tuesday's North American pullback.

Global markets are mixed so far, with Europe firmly down but New York poised for a better open.

"European equity markets are a touch weaker as the negative move that began around lunchtime yesterday has continued," said CMC Markets analyst David Madden.

"In London, the consumer discretionary sector is the biggest faller after Burberry posted figures that failed to meet market expectations."

Tokyo's Nikkei lost 0.4 per cent, while Hong Kong's Hang Seng gained 0.3 per cent, and the Shanghai composite 0.2 per cent.

In Europe, London's FTSE 100, Germany's DAX and the Paris CAC 40 were down by between 0.1 and 0.2 per cent by about 8:40 a.m. ET.

New York futures were up, and the Canadian dollar was just shy of 80.5 cents (U.S.) in advance of the Bank of Canada decision.

"Markets are priced for 85-per-cent chance of a hike at today's meeting," said RBC's Ms. Lignos.

"As to whether the full report will be deemed 'hawkish' or 'dovish,' our rates team argues it will come down to: (1) how the BoC characterizes the interplay between growth and revised potential (whether we are in excess demand next year); and (2) any modifications on the bank's estimate of neutral (currently 2.5 to 3.5 per cent) or hints on the adjustment path to get there," she added, referring to what the central bank deems a neutral rate.

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What else to watch for today

Aside from the Bank of Canada decisions, there are key earnings reports from Bank of America Corp., Goldman Sachs Group Inc., U.S. Bancorp and Alcoa Corp.

Watch, too, as executives of Facebook, Twitter and YouTube are called before the U.S. Senate commerce committee, which has scheduled a hearing to “examine the steps social media platforms are taking to combat the spread of extremist propaganda over the Internet.”

Also on tap is the release of the Federal Reserve’s Beige Book of regional economic conditions.

“The Fed’s regional report will reflect a merry holiday shopping season, an upswing in business spending, and strengthening manufacturing and housing sectors,” said BMO senior economist Sal Guatieri.

“Respondents should express more optimism following the passage of tax reform legislation,” he added.

“On the downside, the report will likely confirm that worker shortages are spreading to more industries and regions. The last report (issued in late November) said employers were raising wages and non-wage benefits to retain and attract workers, a likely precursor of price hikes.”


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