Bank of Canada risks being too optimistic, some economists warn

TORONTO: The Bank of Canada is being overly optimistic in counting on an economic rebound that is unlikely to come, raising the risk policymakers will be forced to cut rates before year end, some market players warned on Thursday.

In holding rates steady on Wednesday, the Canadian central bank pointed to expectations for a return to solid US growth and a bounce back in third-quarter Canadian growth.

But structural change means Canada no longer gets as much traction from US demand that it once did, said David Madani, economist at Capital Economics, who added that a lack of business confidence and a flagging housing market point to a September rate cut. "The economy will be lucky to grow by one percent this year," said Madani.

"It is wishful thinking that the economy is going to rebound strongly." Most analysts polled by Reuters expect the next Bank of Canada move to be a hike, not a cut. Overnight index swaps imply just a 5 percent chance of a rate cut this year.

But the central bank proved itself willing to surprise with a January 2015 rate cut almost no one saw coming. At the time, Governor Stephen Poloz said the benefit of acting swiftly "outweighed the costs of any short-term market volatility."

While he eschews forward guidance, Poloz said in April the bank would probably have considered cutting rates again, if not for fiscal stimulus pledged by the new Liberal government. Many took that as a sign the bank would stay on the sidelines.

But David Watt, chief economist at HSBC Bank of Canada, said the central bank will have to cut rates before year end because counting on the United States, Canada's largest trading partner, to pull the economy out of the ditch no longer works as it once did.

"We're more than 18 months into the decline in oil prices, and four years into a weaker Canadian dollar, and we don't seem to see the manufacturing sector improving," Watt said.

Standard Chartered Bank senior economist Thomas Costerg, who correctly forecast the January 2015 cut, noted Poloz had been vindicated by subsequent data and predicted another easing this year.

"Poloz is not a big fan of forward guidance, so he will react to the data," Costerg said. "I don't think we should expect the bank to send dovish signals before then."