NAFTA CASTS A LONG SHADOW
Bank of Canada holds interest rates steady amid trade talks, Kevin Carmichael says.
The only thing standing in the way of higher interest rates is the uncertain future of the North American Free Trade Agreement.
Canada’s central bank left its official borrowing rate unchanged at 1.5 per cent on Wednesday, stating in the final sentence of the announcement that officials will be “monitoring closely the course of the NAFTA negotiations and other trade policy developments, and their impact on the inflation outlook.”
That line was notable for a couple of reasons.
First, it reflects the urgency of Canada’s talks with the Trump administration, which resumed in Washington at the same time the Bank of Canada updated its policy stance. Negotiators missed a deadline to complete an agreement by Aug. 31, although officials now appear to have decided they have more time. At stake for Canada is preferential access to the market that purchases about three-quarters of its exports.
“The atmosphere continues to be positive,” Chrystia Freeland, the foreign affairs minister, told reporters as she took a break from negotiating. “We are working for a good deal, not just any deal.”
The decision by central bankers decision to mention NAFTA by name in its official policy statement also stood out because, otherwise, they had little negative to say about Canada’s prospects. The only other clouds mentioned were pockets of financial stress in emerging markets and weaker commodity prices. But their obvious satisfaction with the outlook hardened expectations that the Bank of Canada will increase interest rates in mid- October.
“Assuming those downside risks do not intensify over the coming weeks, we believe the (Bank of Canada) will raise interest rates at its October meeting, consistent with its gradual approach to policy normalization,” economists at National Bank said in a report for their clients.
Most Bay Street analysts predicted Governor Stephen Poloz and his deputies on the Governing Council would opt to leave interest rates unchanged in September. The central bank had promised “gradual” increases, and it had just increased the benchmark rate at its last meeting in July. Policy-makers repeated that pledge on Wednesday, saying they continue to favour a “gradual approach” to raising borrowing costs, which “will be warranted” to keep inflation under control.
But even some of those observers might have been surprised by the almost entirely positive tone of the latest interest-rate announcement.
Canadian companies are getting over whatever reservations they had about U.S. protectionism, taking advantage of demand that the Bank of Canada described as “particularly robust.”
Gross domestic product accelerated to an annual rate of 2.9 per cent in the second quarter, twice as fast as the first-quarter rate. On Wednesday, Statistics Canada reported that merchandise exports to the U.S. increased 16 per cent in July from a year earlier, mostly because of higher oil prices. The result is a revived engine of economic growth, taking the burden off the country’s debt-addled households.
“While uncertainty about trade policies continues to weigh on business, the rotation of demand towards business investment and exports is proceeding,” the Bank of Canada statement said. “Despite choppiness in the data, both business investment and exports have been growing solidly for several quarters.”
The central bank shrugged at inflation’s jump to three per cent this summer, the outer limit of its comfort zone. “This was higher than expected, in large part because of a jump in the airfare component of the consumer price index,” the statement said. “The bank expects inflation to move back towards 2 per cent in early 2019, as the effects of past increases in gasoline prices dissipate.”
Policy-makers also signalled comfort with the housing market, noting that prices are “beginning to stabilize as households adjust to higher interest rates and changes in housing policies.” They said gains in hiring and incomes are supporting consumption, an important observation because the central bank has said policy will depend on households’ ability to absorb higher interest rates.
“As past interest rate increases work their way through the economy, credit growth has moderated and the household debt-toincome ratio is beginning to edge down,” the statement said.
The Bank of Canada could face criticism that it risks losing its grip on inflation.
Economists at Bank of Nova Scotia, Canada’s third-biggest bank, predicted Poloz and his deputies would raise the benchmark this week because the economy has been consistently strong for more than a year, yet interest rates remain unusually low. The latest statement suggests the central bank “will largely wait to see inflation before adjusting policy and the obvious risk to doing so is that by that point it may be too late,” said Derick Holt, an economist at Scotia.
Poloz’s counter to that critique has been to say that indicators such as long-term unemployment suggest the economy still has room to expand without stoking inflation. But that room clearly is running out.
Bottom line: Of the concerns Poloz and his deputies have highlighted over the past year or so, only trade remains as a serious worry. If not for that cloud, interest rates would be higher already.