By Fergal Smith and Julie Gordon
TORONTO/OTTAWA (Reuters) - The Bank of Canada is unlikely to cut interest rates to support a flagging economy as long as job growth continues at a robust pace, an analysis of the central bank's response to past divergences in economic data suggests.
The economy could also get a boost from a revival in consumer spending, with next week's federal budget expected to offer incentives that may ease the burden of debt-laden consumers.
The Canadian economy has become sluggish, with trade uncertainty weighing on business investment and a housing downturn hitting consumer spending, prompting speculation the Bank of Canada could cut rates this year.
But the pace of job growth has historically been a better signal for easing than variations in economic growth, Refinitiv data analyzed by Reuters shows. On the last two occasions that job growth and the strength of the economy diverged, in 2006 and 2012, the Bank of Canada chose not to cut rates.
If gross domestic product is expanding at a slow pace "but jobs are blasting ahead, then yes, the bank is unlikely to cut rates," said Royce Mendes, a senior economist with CIBC Capital Markets, cautioning that job data can be volatile.
Dismal economic growth in the fourth quarter prompted the Bank of Canada - which has hiked rates five times since July 2017 - to warn about "increased uncertainty," even as job gains topped 55,000 in four of the last six months.
MORE JOBS, RISING SALARIES
The more dovish tone has led the market to price in about a 30 percent chance of a rate cut this year, whereas before it had been pricing in a potential hike. Canada's 10-year bond yield on Tuesday hit its lowest level since June 2017, dropping below the 1.75 percent level of the central bank's benchmark interest rate.
But experts say the strong employment numbers suggest Canada is facing a temporary soft patch, making rate cuts a risky response that would leave the Bank of Canada little room to maneuver in the case of a real economic shock.
"The jobs data throws into question whether it is really that serious of a soft patch," said Greg Anderson, global head of foreign exchange strategy at BMO Capital Markets in New York.
"This might be a three-month soft patch," he added. "If you spend all your ammunition on a slow patch then there's nothing else."
In addition to the economy churning out jobs, there are signs wages are finally rising, something the central bank has been watching closely.
And Canadians may find their wallets padded further, with the potential for Prime Minister Justin Trudeau's government to introduce measures next week on child care, pharmaceutical care and skills training in the ruling Liberals' final budget ahead of an October election.
"The bank is rightly cautious because even with the job gains that we've had, disposable income growth is really not that supportive," said Mark Chandler, head of Canadian fixed income and currency strategy at RBC Capital Markets.
"It may change if we get something in the budget - tax rates down, transfers up. Then, disposable income might look a little better."
(Reporting by Fergal Smith in Toronto and Julie Gordon in Ottawa; Editing by Paul Simao)