Poloz faces biggest test of cautious stance on interest rates

Experts predict inflation will move well above BoC’s 2-per-cent target

Bank of Canada governor Stephen Poloz’s cautious approach to interest rates is about to be challenged.

While the central banker is expected to hold off from raising borrowing costs for a secondstraight policy decision on Wednesday, and retain a degree of prudence in his rhetoric, Poloz will probably face mounting pressure to return to the ratehike path soon, with inflation and growth starting to pick up.

Economists predict inflation will move well above the Bank of Canada’s 2-per-cent target in the near future, while growth should return to an above-2per-cent pace after a recent slump. It would mark the first time since 2014 that both exceed that level simultaneously. “What makes the Bank of Canada uncomfortable is inflation that is north of target at a time where growth isn’t necessarily that different from trend,” said Ian Pollick, head of rates strategy at Canadian Imperial Bank of Commerce, by phone from Toronto. “That’s an environment where they’ll be forced to do something.”

Poloz has played the cautious card for months, an easy tack to take so long as the numbers backed him up, which they have. Inflation averaged just 1.6 per cent last year, and the economy entered a soft spot in the second half that spilled over into the early part of 2018.

But the backdrop is changing. Economists surveyed last week predict inflation will average 2.3 per cent in the second quar- ter and 2.4 per cent in the third — the highest levels since 2011. And with oil prices marching higher, the risks are tilted to the upside. The Royal Bank of Canada now projects inflation will average 2.9 per cent in the third quarter, at the upper end of the central bank’s 1-to-3-per-cent target range.

Growth, meanwhile, is expected to remain above potential over much of the next two years, starting with a strong rebound this quarter.

When at full capacity, the theory goes, Canada’s economy can’t grow much beyond its potential — estimated by the central bank at 1.6 per cent — without fuelling price pressures and prompting rate increases. And borrowing costs in Canada are still highly stimulative, almost two percentage points below what the Bank of Canada estimates is their “neutral” rate.

But Poloz has indicated he’s in no rush to get there — mainly because, he says, the economy isn’t yet firing on all cylinders.

For the time being, Poloz can rest easy that economists and investors seem to have bought into his cautious narrative.