BoC rate hike an ex­pres­sion of op­ti­mism

Cen­tral bank lifts rate but el­e­vated debt still a con­cern, Kevin Carmichael writes.

Calgary Herald - - FRONT PAGE -

The Bank of Canada fi­nally can see “home” on the hori­zon.

Gover­nor Stephen Poloz and his deputies on the Gov­ern­ing Coun­cil raised the bench­mark in­ter­est rate a quar­ter-point to 1.75 per cent on Oct. 24, as ex­pected.

They said they feel pretty good about the econ­omy, now that politi­cians in Canada, Mex­ico, and the United States have agreed on a re­vised trade agree­ment, and that ev­i­dence sug­gests Cana­dian house­holds are ad­just­ing well to higher bor­row­ing costs. Pol­icy-mak­ers raised their out­look for busi­ness in­vest­ment and ex­ports, sug­gest­ing the econ­omy is be­com­ing less re­liant on debt-fu­elled spend­ing and the hous­ing mar­ket.

“The Cana­dian econ­omy con­tin­ues to op­er­ate close to its po­ten­tial and the com­po­si­tion of growth is more bal­anced,” the cen­tral bank said in lat­est pol­icy state­ment.

Canada’s econ­omy is grow­ing a lit­tle faster than the Bank of Canada pre­dicted a few months ago, and “vul­ner­a­bil­i­ties” from el­e­vated lev­els of house­hold debt are “edg­ing lower,” the state­ment said. Pol­icy-mak­ers re­it­er­ated that in­ter­est rates must rise, and for the first time of­fered a more de­fin­i­tive no­tion of where it wants to go.

“Gov­ern­ing Coun­cil agrees that the pol­icy in­ter­est rate will need to rise to a neu­tral stance to achieve the in­fla­tion tar­get,” the state­ment said.

Poloz, who took over as the gover­nor of Canada’s cen­tral bank in 2014, has talked wist­fully about re­turn­ing in­ter­est rates to a level that econ­o­mists as­so­ciate with nor­mal, a place where the cost of money is nei­ther stim­u­lat­ing ex­pan­sion nor curb­ing growth. The cen­tral bank es­ti­mates that “neu­tral” in­ter­est rate — which Poloz has char­ac­ter­ized as “home” — is some­thing be­tween 2.5 per cent and 3.5 per cent.

There will be a de­bate on Bay Street and Wall Street about how fast the Bank of Canada wants to close the gap be­tween the neu­tral rate and the cur­rent set­ting. Some an­a­lysts and in­vestors will note that the Bank of Canada dropped “grad­ual,” a word that pol­icy-mak­ers had used in three con­sec­u­tive pol­icy state­ments to make sure the pub­lic knew that the econ­omy was fac­ing a lot of head­winds.

There will be a temp­ta­tion to as­sume that the cen­tral bank’s de­ci­sion to erase old mod­i­fiers is a sig­nal that in­ter­est-rate in­creases will be­come more fre­quent. In fact, the Bank of Canada’s out­look is about the same as it was a few weeks ago; if there’s a shift, it’s that pol­icy-mak­ers are more con­fi­dent that out­look will come true.

More likely, Poloz, who has made a point of avoid­ing ex­plicit guid­ance, wanted to keep in­vestors and oth­ers from re­vert­ing to their old habits of putting tex­tual anal­y­sis ahead of num­ber crunch­ing. The new pol­icy state­ment says the pace of in­ter­est-rate in­creases will be de­ter­mined by “how the econ­omy is ad­just­ing to higher in­ter­est rates, given the el­e­vated level of house­hold debt” and “global trade pol­icy de­vel­op­ments.” The res­o­lu­tion of the North Amer­i­can trade dis­pute is a re­lief, but the cen­tral bank ex­pressed height­ened con­cern of the U.S. trade war with China.

Mark Chan­dler, head of Cana­dian rates strat­egy at RBC Cap­i­tal Mar­kets, an­tic­i­pated that the Bank of Canada might change its phras­ing. He ad­vised his clients to avoid over-an­a­lyz­ing any de­ci­sion to re­move “grad­ual” from the state­ment. “While mar­kets may be geared to in­ter­pret this as a clearly more hawkish sig­nal, we sus­pect it would have more to do with the Gov­ern­ing Coun­cil’s un­ease with the (ex­plicit) path it im­plies of 25 (ba­sis points) per quar­ter rather than the data de­pen­dent path they want to em­pha­size,” Chan­dler said in a note pub­lished on Oct. 23.

That’s prob­a­bly right. The num­bers sug­gest in­ter­est rates could be higher, but that un­der­stand­ing of the econ­omy is based on pe­ri­ods when house­hold debt was much lower than it is now. The cen­tral bank went out of its way to state that even though it’s com­fort­able with the way Cana­di­ans are ad­just­ing to higher bor­row­ing costs, house­hold vul­ner­a­bil­i­ties “re­main el­e­vated.”

The Cana­dian econ­omy con­tin­ues to op­er­ate close to its po­ten­tial and the com­po­si­tion of growth is more bal­anced.

SEAN KIL­PATRICK/THE CANA­DIAN PRESS

Bank of Canada gover­nor Stephen Poloz has sig­nalled the need for a “neu­tral” in­ter­est rate, which he char­ac­ter­ized as “home.” It’s a level econ­o­mists as­so­ciate with nor­mal where the cost of money is nei­ther stim­u­lat­ing ex­pan­sion nor curb­ing growth.

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