Bank of Canada raised the overnight rate by 25 basis points to 1.50%

Week in review

CANADA: Housing starts shot up a massive 54.2K in June, coming in at an annualized 248.1K units. Urban starts rose 52.7K (to 228.8K) as increased groundbreaking for multi-unit homes (+54.8K to 172.8K) eclipsed a small decline in the single-unit category (-2.0K to 56.0K). Multi-unit starts were the highest on record for a month of June since data collection began in 1990, with most of the increase concentrated in Toronto (+34.5K to 49.4K) and Montreal (+12.0K to 29.6K). At the provincial level, starts jumped 49.0K in Ontario (to 104.4K) and 18.6K in Quebec (to 59.9K) but fell 9.5K in Alberta (to 26.1K) and 6.5K in British Columbia (to 36.9K). On a quarterly basis, housing starts countrywide were on pace to contract an annualized 9.0% in Q2 (after shrinking 8.0% in Q1), which could translate into a negative contribution to growth from residential construction in the period.

In May, the value of building permit applications progressed 4.7% m/m to C$8.2 billion in seasonally adjusted terms. Construction intentions surged 7.7% in the residential segment but edged down 0.7% in the non-residential category. In the residential category, the value of permit applications increased for both singles (+6.2%) and multis (+8.8%), the latter reaching an all-time high of C$3.1 billion. On a 12-month basis, the value of permit applications slid 0.4% in Canada as a whole.

The Teranet-National Bank Composite National House Price Index^TM climbed 0.9% in June, as 10 of the 11 constituent metropolitan areas recorded increases, led by Ottawa- Gatineau (+2.0%) and Hamilton (+1.8%). Winnipeg was the sole exception (-1.0%). Following this monthly rise, the composite index recovered all the ground lost in 2017H2. Does this mean the home resale market is gearing for a new period of frenzy? No. June's advance was impressive only at first glance: It was actually weak for this time of year. Indeed, purged of seasonal effects, the index stalled in the three months to June. What's more, year-on-year price growth continued to slow in the month, clocking in at just 2.9%, its lowest reading since October 2013. Vancouver (+13.3%), Victoria (+9.3%), Ottawa-Gatineau (+4.7%), Montreal (+3.6%) and Halifax (+3.2%) contributed to lift the national average. Elsewhere, the rise in prices was more subdued.

The Bank of Canada raised the overnight rate by 25 basis points to 1.50%. In making the decision, the BoC was comforted by the fact that the economy was operating at close to full capacity, that the pace of GDP growth seemed set to keep exceeding potential, and that the CPI had risen recently. Although the central bank's outlook assessment remained largely positive, policymakers still fretted about the potential negative impacts of trade uncertainties on investment and exports. As for the protectionist trade measures already imposed by the United States, notably the tariffs on steel and aluminum, the BoC expected these to have no more than a "modest" impact on the economy.

The BoC also presented its updated economic projections in the June edition of its Monetary Policy Report. Expectations for both GDP growth and inflation were upgraded slightly over the forecast horizon. While 2018 growth was left unchanged, the central bank tweaked its quarterly forecasts slightly, hoisting the figure for Q2 to 2.8% annualized and paring it back for Q3 to 1.5%. The composition of 2018 growth was adjusted as well, owing in part to higher oil prices: downgrades to consumption and trade were offset exactly by upgrades to government spending, housing and business investment.

Asked at his press conference why he had opted to raise interest rates in such uncertain times, Bank of Canada Governor Stephen Poloz acknowledged that, although the downside risks associated with trade negotiations and tariff threats were serious, they could quickly evaporate in the event of a positive resolution to the NAFTA negotiations. In his opinion, monetary policy had to be based on what was known and not on hypothetical scenarios. With that in mind and with the Bank's models projecting above-potential growth in 2018-2019 in spite of the trade measures already implemented by the United States and Canada, the BoC deemed it appropriate to raise the overnight rate at this point in time. Looking ahead, another hike was still possible in October if the bank's growth forecasts panned out. That said, the bank reiterated its dependence on data, which was to say that nothing was etched in stone.

UNITED STATES: The consumer price index was up 0.1% m/m in June. Energy prices declined 0.3% while food costs climbed 0.2%. Excluding those two categories, prices rose 0.2% as services less energy increased 0.2% and commodity prices were flat. Year on year, both the headline and core inflation rates gained a tick to 2.9% and 2.3%, respectively. While these two measures stood at multi-year highs, recent momentum has been less impressive. Indeed, core inflation rose just 1.7% in annualized terms in the past three months, hampered by weakness in the core goods segment (-1.0%). Given the USD's vigour since April, we expect the goods category to continue to weigh on overall prices, effectively curbing the current upward trend in core inflation.

Still in June, the producer price index (PPI) for final demand surprised on the upside, climbing a seasonally adjusted 0.3% m/m after rising 0.5% the month before. The increase reflected higher prices for services (+0.4%), especially truck transport (+1.3% m/m, the largest jump since at least 2009) owing to an acute shortage of drivers. Meanwhile, the price of goods advanced just 0.1%, as a 0.8% surge in energy costs was offset by a 1.1% drop in food prices. Excluding the volatile items of energy and food, wholesale prices, too, topped expectations, rising 0.3% m/m for a second month in a row. On a 12-month basis, both headline and core PPI reached their highest levels since 2011, coming in at 3.4% and 2.8%, respectively.

The import price index (IPI) fell 0.4% m/m in June. Although that was the largest monthly drop in 28 months for that indicator, it came after an upwardly-revised +0.9% print the prior month. True, the figure for June was negatively affected by a 0.8% slide in petroleum import prices. That said, prices for imports other than petroleum (-0.3%) also softened on a steep decline in the food/beverages category (-2.6%). On a 12-month basis, the headline IPI weakened two ticks to 4.3% while the less volatile ex-petroleum gauge came down from 1.8% to 1.4%. The year on year tracker of ex-petroleum prices has now declined in 3 of the past 4 months, thereby putting an end to a steady upward trend that had endured from the end of 2015 to early 2018 – the indicator went from -3.7% to 2.0% over that period. If the recent appreciation of the USD is any guide, we might see ex-petroleum import prices decline further in the coming months. That, of course, assumes trade tensions worldwide do not intensify significantly.

In May, consumer credit expanded the most in six months, surging $24.6 billion to an annualized $3,897.7 billion. Nonrevolving credit grew $14.8 billion to $2,858.4 billion, while revolving credit, which consists mainly of credit card loans, increased $9.8 billion to $1,039.3 billion.

According to the Job Openings and Labor Turnover Survey (JOLTS), positions waiting to be filled in the United States totaled 6,638K in May, down from a record-high 6,840K in April. Despite this slight decline, the ratio of job openings to unemployed persons continued its ascension into uncharted territory, climbing two ticks to an all-time high of 1.09 (it peaked pre-recession at only 0.70). In response to the high number of vacancies, hires rose 173K to 5,754K, a summit this cycle. The report also showed that the quit rate (quits as a percentage of total employment) eked up to a cyclical high of 2.4%, as 3,561K Americans chose to leave their jobs in the month, the highest number observed since survey inception in 2000. The recent increase in quits is a clear indication of growing confidence among employees and stiffer competition among employers. Given that job switchers tend to see their salaries rise at a faster pace than job stayers do, the uptrend in quits could translate into faster wage growth.

The NFIB Small Business Optimism Index slid 0.6 point in June but still posted its sixth best print at 107.2. Though the net percentage of firms that expected the economy to improve (33% vs. 37% the prior month) and sales to grow (26% vs. 31%) retreated from the lofty levels reached in May, investment intentions remained high. What<s more, the NFIB report continued to evidence widespread labour shortages, with an all-time high 36% of firms reporting positions they could not fill. Also, 55% stated they could find few or no qualified applicants to fill open positions, another record high. Failing to find suitable candidates, firms sought to retain existing employees, prompting many to raise salaries to this end. No less than 31% indicated enhancing worker compensation in the past three to six months, a high percentage by historical standards. For Q2 as a whole, the NFIB headline index averaged 106.6, its best reading since the mid-80s.

WORLD: After consecutive monthly declines in April and May, China's foreign exchange reserves edged up $1.5 billion in June to $3,110.6 billion. However, this relatively modest increase might precede more significant fluctuations in the months ahead. Here's why. In June, the Chinese yuan (CNY) recorded its worst monthly performance ever against the USD, giving up 3.5% in value. The drop was temporally halted last week by a central bank intervention on the currency market but resumed when U.S. President Donald Trump threatened to impose tariffs on another $200 billion worth of imports from China (on top of the tariffs already levied on $34 billion worth of Chinese goods). Pundits have put forth various reasons for the tumble. While the souring of trade relations with the United States ranks high on their list, the painful deleveraging process initiated by Chinese authorities in recent months has also been emphasized. The finger has also been pointed at the U.S. Federal Reserve, whose tightening of policy is no boon for emerging-market currencies.

In any event, the situation has deteriorated to the point that some analysts have turned into doomsayers where the CNY is concerned. Backing their view is the fact that several options normally available to support the currency are now unlikely to be exercised. Raising interest rates, for instance, might be off limits for a highly leveraged economy that has shown signs of slowing recently. This month's decision by China's central bank to reduce the amount of cash that banks must hold in reserve suggests that officials are tilting more on the side of loosening than on the side of tightening. Another possibility could be to impose even stricter capital controls. However, this is unlikely after years spent trying to convince foreign investors of China's commitment to an open economy. Under the circumstances, the only choice left open to support the CNY might be for Chinese authorities to tap into the country's international reserves, as they did back in 2015-16. If they opt to go down this route, they still have plenty of dry powder on hand. Indeed, reserves presently amount to 22% of GDP, a ratio far superior to that of any other emerging country and certainly sufficient to afford the central bank some breathing room. Then again, Chinese authorities could be comfortable with letting the currency depreciate further.

The Chinese currency was not the only asset affected by growing trade tensions this week; oil prices also took a hit. On Wednesday, Brent crude sank $5.46, the biggest daily drop in nearly 7 years. WTI didn't fare much better, shedding $3.73. As in the Yuan case though, the tariff threat directed at China by the U.S. was but one of the factors explaining crude oil's weakness. The reopening of several key export terminals in Libya, as well as the announcement by OPEC that Saudi Arabia had increased production by more than 400,000 barrels a day in June, also contributed in rattling energy markets.

Download The Full Weekly Economic Letter