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KEVIN CARMICHAEL: GO AHEAD, FOLLOW THE ANALYSTS & JUMP ON THE BANK OF CANADA INTEREST RATE HIKE BANDWAGON — THERE ARE PLENTY OF REASONS.
Economists at Bank of Montreal got some free publicity this week for doing nothing more than joining the pack. Their peers at National Bank were the first to predict the Bank of Canada would raise interest rates next week. Four of the Big Five banks followed a week ago, after Statistics Canada reported that the unemployment rate in December was the lowest in at least four decades.
The crew at BMO delayed, a decision that brought it some extra attention when chief economist Douglas Porter announced on Monday that he too had advanced his forecast to Jan. 17.
Nothing against BMO, but the holdout everyone should have been watching this week was the top economist at Canada’s No. 7 bank, the relatively tiny Laurentian.
Unlike most of the Bay Street bunch, Sébastien Lavoie, a former Bank of Canada researcher, is skeptical about the need for significantly higher interest rates. That outlook served him well early in 2017, when the central bank dismissed a burst of positive indicators, although he was caught off guard when interest rates were finally increased over the summer. If Lavoie joined the bandwagon, then an interest-rate increase was pretty much assured.
Drum roll: Lavoie flipped. If you haven’t, you probably should too. The Bank of Canada says it is “data dependent,” and the data are too good to ignore.
At the end of last year, it looked like the central bank would leave interest rates unchanged for at least a few months longer. Most indicators were strong, but there was reason to worry about the future.
The U. S. president kept talking about ending the North American Free Trade Agreement, and the possibility of a war involving North Korea had become part of the zeitgeist. As long as inflation stays in check, the threat of war — trade and/or nuclear — is a good reason to leave borrowing costs low.
Governor Stephen Poloz also had refined his thinking about where Canada might be in the economic cycle. Standard relationships between economic growth and inflation suggested the central bank should be applying coolant. But Poloz sensed a rare opportunity to strengthen the economy’s ability to expand without putting upward pressure on prices.
EVERYONE SHOULD HAVE BEEN WATCHING LAVOIE
Every economy has a speed limit at which its ability to keep up with demand becomes strained and costs start to rise. By keeping interest rates unusually low, Poloz is trying to encourage companies to invest and hire, which would increase the speed at which Canada’s economy can travel without overheating.
“We want the economy to grow hotter for a while so it uses up that excess capacity that still is in the labour market,” Poloz said in an interview with the CBC on Dec. 15.
Or course there’s hot, and then there’s red hot.
Canada added 422,500 j obs in 2017, the second most in 30 years; 79,000 of them came in December, a huge gain by historical stan- dards. And at 5.7 per cent, the unemployment rate suggests Canada is near or at full employment, the point at which economists think continued hiring would put undue pressure on inflation. The labour market rarely has been stronger, yet interest rates still are close to an emergency setting. That calls for a shift.
The moment is reminiscent of last summer, when the Bank of Canada finally accepted that the rebound from the collapse of oil prices was real. It resisted changing policy until StatsCan reported that gross domestic product grew at an annual rate of 4.5 per cent. Policy makers are inclined to keep borrowing costs relatively low, but they have been clear that they will respond whenever indicators send a clear signal. The central bank followed the outsized GDP re- port with quarter- point increases at consecutive meetings in July and September. Next week, they likely will resume what they started seven months ago.
Unanimity among analysts will have little influence on Poloz. “The Bank of Canada,” unlike, say, the Federal Reserve, “is not the type of central bank that moves on market expectation,” Shailesh Kshatriya, a director at Russell Investments, said in an interview.
Still, the governor is on record saying he hopes to learn from market pricing and the debate among investors and economists. And the quality of research ahead of next week’s decision is better than what has passed for day- today analysis of monetary policy in recent years.
Rather than attempting to divine meaning from the various utterances of central bankers, Bay Street has produced some quality research. Work by economists at National Bank and Toronto-Dominion Bank stands out. In his final speech of 2017, Poloz expressed concern over the elevated level of youth unemployment; National Bank’s Matthieu Arseneau and TD’s Brian DePratto responded with reports that show the kids actually are all right, suggesting the jobless rate of younger people needn’t be a barrier to a shift in policy.
There are other barriers. The uncertainty around trade and Trump’s tax cuts could divert business investment to the United States. The central bank is confident that new lending standards will wean households off credit, but it is less sure of how consumers used to money for nothing will respond to higher interest rates.
Policy makers also will be wary of putting upward pressure on the currency, which has been whipped around by traders’ expectations for in- terest rates and suggestions the NAFTA talks are failing. Those are strong arguments for following any increase with another long pause. Lavoie and Kshatriya see only two quarter- point increases in 2018, which seems the right call at this stage.
Remember, Poloz is inclined to let the economy run hot. One indicator he has said he will be watching closely is average hourly wages.
They increased 2.7 per cent in December from a year earlier, matching the monthly average in StatsCan data that dates to 1998. But wages only have been rising for a few months, following a long period of decline.
“Policy makers don’t have a tremendous amount of runway,” before wages trigger inflation, said Kshatriya. But they have some. Bottom line: you should expect them to use it.