BANK OF CANADA HIKES RATE WITH EYE ON TRUMP.
The future of NAFTA weighs heavily
Multibillionaire Ray Dalio, the head of Bridgewater Associates, the world’s biggest hedge fund, says politics will drive markets in 2018, marking an end to the postcrisis dominance of central bankers.
And don’t Canada’s mast ers of monetary policy know it.
The path for interest rates this year will be determined to a significant extent by the economic policies of U. S. President Donald Trump and how Canada’s elected representatives react to them.
Governor Stephen Poloz and his deputies on the Governing Council used their first policy announcement of 2018 to raise their benchmark lending rate a quarter point to 1.25 per cent.
Hiring was much stronger than expected over the fall, and having said they would be guided by data, central bankers were compelled to add to previous increases in July and September.
It could be the easiest decision they make all year.
At 5.7 per cent, the jobless rate is at a level that most economists associate with full employment, the state at which additional hiring would begin to put serious upward pressure on inflation. On paper, the economy doesn’t need more stimulus, so interest rates should be on the rise to keep prices in check.
Except the Bank of Canada isn’t ready to go there.
“Governing Council judges that while the economic outlook is expected to warrant higher interest rates over time, some continued monetary policy accommodation will likely be needed to keep the economy operating close to potential and inflation on target,” senior deputy governor Carolyn Wilkins said in prepared remarks after the interest rate decision.
T he main reason is Trump.
If not for the U. S. president’s repeated threats to end the North American Free Trade Agreement, the Bank of Canada reckons the economy would be even stronger.
WHILE THE ECONOMIC OUTLOOK IS EXPECTED TO WARRANT HIGHER INTEREST RATES OVER TIME, SOME CONTINUED MONETARY POLICY ACCOMMODATION WILL LIKELY BE NEEDED
Uncertainty over trade is starting to paralyze corporate decision- making, reducing the level of investment one might associate with an economy as strong as Canada’s over the past year. Executives might even be diverting money that could have ended up in Canada; the central bank observed in its latest quarterly economic report that greenfield investment by Europeans and Americans has declined since mid-2016. That’s odd, given Canada had the fastest growing economy in the Group of Seven last year.
NAFTA, “is the biggest issue in the forecast space,” Poloz said.
It’s not the only issue, of course, and Poloz insisted that it would be a mistake to assume that a breakthrough at the NAFTA talks would prompt the central bank to raise interest rates at its next opportunity.
Policy- makers think faster economic growth might actually help them contain inflation by encouraging companies to expand, and by spurring workers to seek more hours and higher paying jobs. The combination of those things would enhance the economy’s ability to produce non- inflationary growth.
Another consideration: the Bank of Canada said a re- examination of revised data shows the economy has greater potential to expand without affecting prices than it previously thought. Put together, Canada’s cent ral bankers t hink t hey have some more runway before inflation gets dangerously hot. A key indicator of whether an economy is beginning to overheat is a spike in wages. The central bank reckons wages are growing at an annual rate of around 2.2 per cent, or about the same as inflation. In other words, lots of Canadians still are waiting on the benefits from stronger-than-expected economic growth in 2017.
“Wages have picked up but are rising by less than would be typical in a the absence of labour market slack,” the Bank of Canada said in its policy statement.
Professional forecasters are divided on where rates are headed: some see only one more increase in 2018; many predict two additional hikes; and others see three, which would leave the benchmark at 2 per cent by year-end.
But anyone who foresees a steady return to a more normal pattern of interest rate setting this year must also assume that Trump will adopt a less confrontational approach to trade. That’s possible; Agriculture Secretary Sonny Perdue told Bloomberg News on Jan. 17 that he thinks his boss has “come to realize that agriculture has been benefited by a NAFTA agreement.” And the White House insists it is negotiating in good faith.
The problem with giving Trump the benefit of the doubt is that he now has a track record that suggests he doesn’t deserve it.
Even if the threats to quit NAFTA are tactical, the president has done enough to show that he likes the chaos, which fits with his carrot-and-stick approach to industrial policy. The drumbeat of negativity about trade, mixed with a more aggressive use of retaliatory tariffs will prompt companies that want a share of the American market to set up in Trump’s realm. And if that wasn’t enough, Republicans at the end of last year added an extra incentive by cutting taxes on business income and investment.
Those tax cuts worry the Bank of Canada. The central bank assumes only a “small” benefit for Canada because any increase in demand for exports will be almost completely offset by lost investment. That will put pressure on Finance Minister Bill Morneau and the provinces to counter Trump with tax measures of their own.
And maybe they will. But until they do, one thing that might keep investors interested in Canada is the prospect of lower interest rates. The Bank of Canada made clear that it is prepared to do what it can; the politics of the Trump era has left it little choice.