The gulf between the Fed and the Bank of Canada is growing.
A TALE OF TWO ECONOMIES
• Canada and the United States may be joined at the hip geographically, yet from an economic and monetary policy perspective, the gulf between the two countries is becoming apparent once again.
Canada now has the best performing economy among industrialized nations, according to the International Monetary Fund. We are, says the economic development watchdog, also ahead of the curve in tightening interest rates — even as our neighbour to the South looks to be staying the course for a little longer.
Not long ago, the opposite was true.
At the start of 2016, the U. S. had already begun unwinding its nearzero rate regime and set a course for a handful of incremental increases in borrowing costs. At the same time, other major central banks — including in Canada and Europe — were cutting interest rates.
During an Ottawa speech in January of that same year, Bank of Canada governor Stephen Poloz stressed it was “important that we understand the reasons for these policy divergences.”
“On one level, they simply reflect actions taken by central banks tailored to their own economies. But the underlying forces acting on the global economy are powerful, slow moving and affect various economies differently. This means that the theme of divergence — both financial and economic — is likely to remain with us for some time to come.”
The IMF, in its updated forecast last week, said it sees the Canadian economy expanding by 2.5 per cent this year, up 0.6 percentage points from the agency’s April outlook, while output next year is anticipated to be just shy of two per cent.
Growth projections f or t he United States, meanwhile, “are lower than in April, primarily reflecting the assumption that fiscal policy will be less expansionary going forward than previously anticipated,” the IMF said. Output has been revised down from 2.3 per cent to 2.1 per cent in 2017, and from 2.5 per cent to 2.1 per cent in 2018.
On Friday, the latest monthly data showed Canada’s economy still gaining momentum. Statistics Canada reported a consensus- beating 0.6-per-cent increase in May, following a reading of 0.2 per cent a month earlier.
All told, that puts t he a nnual growth rate at around three per cent, bettering the IMF’s 2.5-percent annual outlook f or this country.
“Wh i le the blow- out headline advance no doubt exaggerates the underlying strength in growth, the fact is that every single major surprise for the economy this year has been to the upside,” said Douglas Porter, chief economist at BMO Capital Markets.
“With this powerful momentum, even if some of it is a passing phase, it will take a lot to knock the Bank of Canada off its gradual tightening path.” One major piece of the big economic picture, however, will come Friday, when Statistics Canada posts its employment survey for July.
Meanwhile, the U. S. on Friday reported that second- quarter economic output grew by a pace of 2.6 per cent, up from 1.2 per cent in the previous quarter.
IT WILL TAKE A LOT TO KNOCK (THE BoC) OFF ITS GRADUAL TIGHTENING PATH.
Still, the U. S. Federal Reserve’s decision last week to hold off on its long- planned winding down of more than US$4.5 trillion in total bond holdings, the result of a runup in purchases that began in wake of the 2008- 09 global recession, has put a big “if ” in front of the central bank’s exit strategy from so- called “quantitative easing.”
But U. S. Federal Reserve chair Janet Yellen and other members of the Federal Open Market Committee have attempted to downplay any concerns that the bank was sitting idle when possibly more stimulus is required.
“Consistent with its statutory mandate, the committee seeks to foster maximum employment and price stability,” the Fed said in its statement.
“The committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labour market conditions will strengthen somewhat further,” it said. “The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labour market conditions and a sustained return to twopercent (target) inflation.”
September now l ooks more likely for a Fed hike, according to many analysts, but only if global uncertainties and nervousness over the direction of the new U.S. administration begin to dissipate. Others think a rate increase could be months away.
The Fed has raised its benchmark borrowing level on four occasions since December 2015, taking it to the current range of between one and 1.75 per cent. The Bank of Canada, meanwhile, upped its base rate to 0.75 per cent on July 12, an increase of 25 basis points, after a sevenyear hiatus on tightening. The European Central Bank and the Bank of England are similarly looking primed to nudge rates higher.
As with the Bank of Canada, one of the Fed’s key monetary policy concerns is the pace of price increases — an indicator of the willingness of consumers to spend or hold onto their money — while another gauge is the pace of unemployment.
“Weak inflation remains a thorn on the Fed’s side and markets are skeptical that the Fed can hike more than a few times in the next couple of years,” said Emanuella Enenajor, portfolio manager at New York investment group BlackRock.
“But with the jobless rate declining, wages gradually rising and financial conditions remaining accommodative, the ingredients for stronger underlying inflation are in place. We think the Fed could hike in December, but it’s a close call if core inflation readings remain subdued. Further out, rising wages and inflation could see a handful of further 25-basis-point rate increases,” Enenajor said.
“We think the Fed is telling the markets loud and clear to get ready for balance sheet normalization. They have telegraphed this for months, so it shouldn’t be a surprise if in September, they announce the change in policy. The bar for this move seems quite low and we see this as a continued gradual exit from a highly accommodative framework.”