BOC cut will pressure Ottawa for fiscal response
A Bank of Canada rate cut won’t be enough to mitigate the economic fallout of the coronavirus, turning all eyes to Ottawa for measures to stabilize jittery markets and restore confidence.
A surprise move by the U.S. Federal Reserve to cut its interest rate by 50 basis points Tuesday makes a parallel move by Bank of Canada governor Stephen Poloz all but certain, analysts say. The Fed cut will see the target rate for federal funds fall to between 1 per cent and 1.25 per cent.
Poloz is widely expected to cut Canada’s current benchmark interest rate of 1.75 per cent by 25 to 50 basis points on Wednesday.
But while lower rates can ease lending and encourage consumers to spend, they cannot address supply chain disruptions or calm nerves about the spread of the virus — making a fiscal response from Ottawa all the more likely as countries scramble to keep their economies moving, analysts say.
“We are dealing with something that has nothing to do with monetary policy,” said CIBC economist Benjamin Tal. “In this environment fiscal policy is more effective so I will not be surprised if we see some changes there and a compromise on the deficit as a result.”
Those changes could take the form of accelerated capital expenditure writeoffs or direct spending on infrastructure to stimulate the economy, Tal said.
“Whatever they do they have to make sure it’s reversible, and tax cuts are hard to reverse,” he added. “So I think we’ll see direct spending. But the pressure will be on fiscal policy to carry the day until this situation stabilizes.”
That could be a tall order as Finance Minister Bill Morneau endeavours to soothe concerns about a widening budget deficit, already running higher than initial estimates. Morneau will table his budget in the upcoming weeks amid slowing domestic and global growth and now, deepening concerns about the coronavirus.
On Tuesday, Morneau said the government has the fiscal room to move if needed.
Morneau took part in a Group of Seven conference call on the global health crisis in the morning, which stopped short of spelling out a specific policy response. His office later signalled a willingness to spend more if circumstances demand it. “Our strong fiscal position continues to give us the necessary leverage to respond,” press secretary Maéva Proteau said by email.
Prime Minister Justin Trudeau, meanwhile, left the door open to targeted government aid. “There will be impacts on Canadian businesses, on entrepreneurs, and we will always look for ways to minimize that impact and perhaps give help where help is needed,” the prime minister said in Halifax.
Beata Caranci, chief economist for TD Bank, said some sectors could already be suffering. “The tourism sector is an obvious one. The first point of contact for pain is in that sector.”
The Fed’s emergency cut to the U. S. rate is the first since 2008 financial crisis. Regulators may have felt the need to act given the hefty economic toll the illness has taken elsewhere, Caranci said. China, for instance, is expected to have its first recorded economic contraction in the first quarter while Italy, the nexus of the European outbreak, will likely also see its economy continue to contract, she said.
“There’s a high degree of uncertainty but what the Fed can do is observe what’s been happening off its shores and see that it’s having quite strong impacts,” Caranci said. “They’re probably presuming if it’s happening there, why would we presume we’d be completely isolated from that?”
Whatever the reason, the Fed’s step will make it difficult for the Bank of Canada to justify leaving its own rate untouched. Canada’s economic growth has been weaker than in the U. S., it has been hit by more “idiosyncratic shocks” like rail disruptions and the country already has the highest policy rate of any advanced economy, Caranci noted.
“To my mind, the only question is whether they cut by 25 or 50 basis points,” she said. “At this point the market has priced in higher odds that they move by 50 basis points so now they have to justify, why they won’t take that larger step. What makes Canada different?”
The answer to that question comes back to Canada’s high level of household debt, she added. Due to soaring house prices, Canadians now carry debt of $ 1.76 for every dollar in disposable income they have — the highest of all G7 countries. Low interest rates could further fuel that ratio, some fear.
For his part, Tal expects concerns about the virus to offset a boom in housing and associated debt as a result of an interest rate cut.
“Interest rates are already low to start with and getting into the market is a big responsibility when people are concerned about the long- term impact of the virus,” he said. “I do expect more creative moves from all governments to ease those concerns.”