New neutral rates to be below old norm: report
Interest could hover around 3 per cent
OTTAWA — Interest rates have been low for longer than anyone could have imagined, with the global economy initially rebounding from the recession and then struggling to maintain that expansion.
Canada is no exception, except for one important fact: This country will likely forever be hitched to the U.S. growth engine — and so it is with borrowing costs, even though the timing and level of rate increases may differ slightly.
A report Wednesday by TD Economics looks at where the eventual rise in rates for both countries may come to rest. In other words, what will be the “new neutral” — the not-too-hot, nottoo-cold so-called Goldilocks level — set by central banks to keep economies running at full output capacity without causing a spike in inflation.
Before the recession, many monetary policymakers and private-sector economists pegged the neutral rate for both Canada and the United States at between four per cent and 4.5 per cent. The new long-run level is expected to be closer to three per cent in Canada and 3.25 per cent in the U.S., according to the TD report.
After some incremental increases after the economic downturn, the Bank of Canada’s benchmark overnight rate has been untouched at one per cent since September 2010, while the U.S. Federal Reserve has kept its key lending level — the fed funds rate — at zeroto-0.25 per cent for nearly six years.
But with the U.S. Fed signalling an October end to its massive monthly bond-buying program — or “quantitative easing” — financial markets are now focusing on how the Fed will move toward a more normal balance of its monetary policy.
“It will be a lengthy process to return to neutral, with the first step in raising the fed funds rate occurring no earlier than June 2015, and the Fed moving in a gradual, step-wise fashion over a period of three years,” the TD report says. “Although the exact timing of the first step is highly dependent on labour market conditions, inflationary pressures, inflation expectations and financial developments, investors and economists appear in agreement that 2015 will mark the start of the tightening cycle.”
The Bank of Canada, meanwhile, has taken the term “neutral” to a different level in the past year — referring, instead, to governor Stephen Poloz’s decision to adopt a neither-upnor-down stance on the next rate movement.
Even so, most policy watchers still expect Poloz to follow the more obvious route and begin raising borrowing costs in this country around the same time as the Fed’s first hike.