Bracing for the next economic shock
American election may create uncertainty over interest rates
Two years ago, the global collapse in oil prices rattled financial markets and choked resources-reliant economies like Canada’s. But by late 2015, much of the damage seemed to have been contained and signs of stability were beginning to appear.
The U.S. central bank, for example, had already set a course for a series of interest rate hikes — the first coming in December of last year — after spending more than a half-dozen years in a holding pattern.
The Bank of Canada had gone its own way, slicing borrowing costs twice in the first half 2015 as “insurance” when the energy crisis pulled the much more oil-dependent Canada into a short-lived recession. The economy had been expected to pickup overall this year, despite a second-quarter hit from wildfires in the Alberta, which sidelined a large portion of oil production.
Then along came the Brexit campaign and with it the real possibility that the June 23 vote to pull out of the European Union could set the U.K.’s economy — the world’s fifth largest — into a tailspin, fuelled by uncertainty over how and when the exit would actually happen.
“So now, we’re kind of looking around and wondering where the next shock is going to come from,” said Ethan Harris, head of Global Economics at Bank of America Merrill Lynch in New York. “And it looks like there’s at least some chance we’ll get a homegrown shock this time.” Cue the U.S. presidential race. “The way the election impacts the markets and the economy is by creating uncertainty — uncertainty about what policies are going to come, uncertainty about who the winners and losers are going to be after the election,” Harris said. “In the next few months, the thing we’ll be watching closely is this question of whether the election itself creates a lot of uncertainty in the markets and slows down decisionmaking in the economy.”
But the immediate impact could be on the course and timing of interest rate decisions in both the U.S. and Canada — with the likelihood those decisions will go in different directions.
The Bank of England already bit the bullet, cutting its key lending level to a historic low of 0.25 per cent last week — and leaving open the option to lower borrowing costs again, if necessary, to help buffer the U.K. from the as-yet unquantified damage of the vote to leave the EU.
The U.S. Federal Reserve, meanwhile, kept its trendsetting overnight lending rate between a range of 0.25 to 0.5 per cent during its July meeting — amid uneven monthto-month employment data — and continued a pullback from its original plan to raise the lending level in four stages this year.
But Fed chairwoman Janet Yellen maintains a hike is still possible “in the coming months.” The next policy meeting is set for Sept. 20-21, but it’s more likely that a decision to finally increase rates again will happen at the Dec. 13-14 meeting.
“We’re still looking at December,” said Robert Kavcic, senior economist at BMO Capital Markets in Toronto.
However, the Fed “has shown a willingness to back off and wait for some of the uncertainty to pass,” he said. “We’ve seen it, for example, with Brexit. So they have a bit of a precedent on that front to sit back and wait for uncertainty to pass before moving.”
Uncertainty is a real issue for Canada’s monetary policy-makers as well. Bank governor Stephen Poloz is faced with a struggling economy that has been hampered by weak employment growth and disappointing exports, and waiting for promised fiscal stimulus from the federal government to trickle down to local communities, along with the already enhanced Canada Child Benefit program.
Although the economy grew by at a strong annualized pace of 2.4 per cent in the first quarter of 2016, the second quarter is estimated to have contracted by as much as two per cent, hampered by disappointing trade performance flows and uneven consumer spending — on top of the devastating Alberta wildfires.
The BoC’s next rate decision is on Sept. 7. But a change in policy, if any, is not expected until the bank’s Oct. 19 rate announcement when Poloz also releases the quarterly Monetary Policy Report — an updated review and forecast for the domestic and global economies.
BMO’s Kavcic said a quarterpoint cut “isn’t going to make a difference” to the overall economy, but could further fuel the housing markets in Vancouver and Toronto.
For over-extended Canadians, any reduction in lending rates “is a message to consumers and homebuyers to just go ahead and borrow more and take on more debt,” he added.