Poloz turns hawkish as rate hike looms

Amid economic growth spurt, more than one increase expected

OTTAWA— No one doubts the Bank of Canada will raise interest rates again soon. The country’s economy has turned out to be much stronger than anyone was predicting only a few months ago, giving policy-makers scope to bring rates back up to more normal levels.

The only debate is whether governor Stephen Poloz will move at Wednesday’s meeting or wait until October, and whether current projections for as many as three more rate increases by the end of 2018 are too conservative.

Economists are primarily in the wait-a-month camp — only five of 26 surveyed by Bloomberg expect the central bank to hike its 0.75-per-cent benchmark rate this week.

Investors are hedging, with traders assigning a 57-per-cent chance of an increase.

The main benefit of waiting until the October decision, which coincides with new quarterly forecasts and a press conference, is that it gives Poloz time to provide more direction to investors about how he sees the data, presumably to limit unnecessary market volatility.

At Wednesday’s decision, all investors will get is a press release of about 300 words.

“We expect to see a bit more of a hawkish tone in the September statement setting up October, but from a communications perspective, it favours an October move,” said Brian DePratto, an economist at Toronto-Dominion Bank.

At the same time, Poloz already laid the groundwork for any future hikes at the July 12 rate decision, which was also accompanied by new forecasts and a press conference, by saying the next move would be “guided by incoming data.”

The data has been almost universally strong, including a GDP report last week that confirms the country is in the middle of its strongest growth spurt in more than adecade and eating into slack much more quickly than the Bank of Canada had anticipated only two months ago.

Nor is it uncommon for the central bank to move at rate decisions that aren’t accompanied by its so-called Monetary Policy Reports (MPR).

Since the current format was instituted in 2002, 16 of the 37 rate moves have occurred in non-MPR rate decisions.

In a span of a few months, Poloz has gone from being seen as overly dovish to one of the world’s more hawkish central bankers.

The Bank of Canada is now expected to move faster on interest rates than even the Federal Reserve.

While futures trading implies the Bank of Canada will hike rates almost three times by the end of 2018, they are barely pricing in a full hike for its U.S. counterpart over the same stretch. This explains why yields on two-year government bonds in Canada have surged in recent weeks and are now at about parity with the U.S.

Canada is seen catching up with the U.S. on short-term rates by the end of 2018.

Then again, there isn’t much Poloz can do about the data.

Few developed economies are growing as quickly as Canada.

Quarterly growth has averaged 3.7 per cent over the past four quarters, compared to 2.2 per cent in the U.S. Economists are now projecting growth of above 3 per cent in Canada for all of 2017, a full percentage point above the U.S.

Beating the U.S. by a full percentage point or more has happened only five times since 1980.

While there are plenty of reasons to conclude rate hikes are in store for Canada, it’s tougher to see the country’s central banks getting far ahead of the Federal Reserve. Canada has made up much of the ground it lost to the U.S. recovery after oil price collapsed in 2014, but there’s still some way to go.

Since the end of 2013, U.S. growth has averaged about 2.2 per cent versus 1.9 per cent in Canada. That plays into the idea that the U.S. cycle is more advanced than Canada’s — as Poloz had been known to emphasize until recently.

Further, there’s no sign of significant inflation pressure and the Bank of Canada is an inflation-targeting central bank.

“They have the luxury of waiting until October simply because they don’t have the smoking gun of inflation,” said Mark Chandler, head of fixed income research at Royal Bank of Canada.

Plus, policy-makers will want to limit any further gains in the loonie, which is up almost 9 per cent since early June, when the central bank first adopted a tightening bias.

That ties in closely with concern about the sustainability of the recovery, which has relied heavily on consumers and housing.

Since the start of 2014, consumption and residential investment has accounted for 90 per cent of all growth.

Over the last four quarters, that’s come down to about 62 per cent, close to the historical average, on the back of business spending on investment and inventories that’s already much stronger than usual and will probably slow. The last thing businesses need is a stronger loonie.

Along with the GDP data last week, Statistics Canada released a methodically consistent revision of national accounts that allowed it to provide comparable data going back an additional 20 years, to-1961 instead of1981.

The revisions showed that in the first half of 2017, household consumption and residential investment combined totalled 64.3 per cent as the share of the total economy, a record.

This provides possibly the strongest argument for why policy-makers should be cautious when it comes to raising rates: it’s not exactly clear how the Canadian economy will react, since it’s all unprecedented.

Borrowing costs have never been this low, Canadians have never been as indebted and the nation’s economy has never been so reliant on consumption and housing.