Trump actions hamper investment, BoC says

executives, who must decide how they want to exploit the North American market. Trump’s desire to either overhaul or quit the North American Free Trade Agreement, along with his capricious use of retaliatory tariffs, is causing companies to hedge the risk of higher border taxes by adding factories and offices in the U.S. instead of Canada or Mexico.

Washington’s massive corporate tax cuts at the end of last only exacerbate the trend. “Our economic projections have been incorporating the judgment that such effects are likely to dampen business investment,” said Lane, who added that exports remain a disappointment, which also could reflect a reluctance on the part of executives to expand in Canada.

“Although Canadian manufacturing activity has been solid in recent quarters, non-energy exports could disappoint, given ongoing competitiveness challenges,” Lane said. “Indeed, in 2017, these challenges meant Canada was unable to benefit fully from a strengthening in global trade.”

In other words, Trump is winning.

Some will worry that the Bank of Canada’s emphasis on foreign direct investment and trade will cause policymakers to lose their grip on inflation. Asset-price bubbles, especially in housing, also will linger as a concern, as lower borrowing costs could encourage more borrowing.

To be sure, the central bank appears to feel pretty good about the domestic economy.

If there was a surprise in Lane’s speech, it was his rosy interpretation of the state of investment by Canadian companies. That’s been a serious weakness for sometime, as the collapse in oil prices in 2014 and 2015 rippled through the economy. But recent figures suggest years of ultra-low borrowing costs and stronger global demand are coaxing executives to spend. Statistics Canada’s recent report on fourth-quarter gross domestic product showed business investment grew at annual rate of 6.9 per cent over the final three months of the year, a number that Lane called “strong” and “encouraging.”

That’s the most enthusiastic the central bank has sounded about domestic investment in years. Lane also described economic growth in 2017 as “robust,” and said that he and his colleagues see the economy cooling to a “sustainable pace” of growth this year.

But the central bank isn’t panicked about inflation, and therefore wouldn’t feel compelled to raise interest rates quickly even if normalcy prevailed in Washington.

Increased investment boosts Canada’s capacity to produce goods and services. All things equal, that reduces inflationary pressure because companies are better able to keep up with demand. And Poloz is inclined to let the economy run a little hot because he thinks he has a unique opportunity to increase capacity and make the economy stronger for years to come.

Lane said “elevated” levels of long-term unemployment and youth unemployment suggest there still is some slack in the labour market, suggesting policy-makers think they can get away with leaving interest rates relatively low for a little longer yet.

The final thing to note about the Bank of Canada’s latest round of commentary is its decision to talk about what’s happening with credit. Lane reiterated the policy statement’s observation that households have reduced their borrowing for several months now, suggesting that higher interest rates and tighter mortgage rules have reduced the threat of housing bust.

So there are a lot of positives, but they are outweighed by one big one. The federal government opted against a fiscal response to Trump’s policies in last month’s budget. That means there is extra pressure on the central bank to do what it can to offer some stimulus. The result: its decision to leave its benchmark rate unchanged at 1.25 per cent this week.