Cautious Bank of Canada holds the line
Preventing freefall in consumer confidence key factor in decision to keep interest rate at 0.5%, governor says
Canada’s economic prospects have worsened since October and could take until the end of 2017 to fully recover, the Bank of Canada said Wednesday.
Alot will depend on what’s in the Liberal government’s first budget, bank governor Stephen Poloz said, as the bank unexpectedly backed away from plans to cut its trendsetting interest rate.
Since its last forecast in October, “prices for oil and other commodities have declined further and this represents a setback for the Canadian economy,” the bank said in its Monetary Policy Outlook.
However, the bank opted to stand pat at 0.5 per cent, instead of taking the rate back down to its post-recession low of 0.25 per cent.
In a rare glimpse into central bank thinking, Poloz said officials were concerned about the effect a rate cut could have on consumer confidence as falling oil prices and a plunging dollar take a bigger bite out of Canadians’ pocketbooks.
“We know the Canadian economy is absorbing a pretty substantial reduction in national income because of the lower price of oil,” Poloz said during a press conference in Ottawa. The bank has previously estimated the impact at $50 billion, or $1,500 a person, a year for the next three to five years.
The move came on a day when a worsening outlook for oil sent global financial markets on another rollercoaster ride. The Toronto Stock Exchange benchmark index lost159.13 points to close at 11,843.11 points, down nearly 9 per cent since the start of the year. Markets in New York, Europe and Asia also closed lower as oil plunged another 4 per cent to close at $28.35 (U.S.) a barrel.
Oil is down more than 70 per cent from its peak in June 2014 on falling demand and a glut of supply.
Abright spot was the Canadian dollar, which gained nearly a third of a U.S. cent to close at 69.01 cents U.S., the first time since the start of 2016 that it has ended the day higher. It has fallen 16 per cent in the past 12 months.
In Davos, Switzerland, Prime Minister Justin Trudeau moved to reassure the world’s business and political elite that Canada is still a good place to invest, despite the wallop from plunging prices for crude.
“We have a diverse and creative population, outstanding education and health-care systems, and advanced infrastructure. We have social stability, financial stability and a government willing to invest in the future,” Trudeau said in a speech to the annual gathering of the World Economic Forum.
Rate cuts normally boost economic growth by encouraging consumers and business to borrow. But economists had urged the Bank of Canada to proceed with caution, saying a rate cut at this time could further depress the Canadian dollar, undermine consumer confidence and hamper business decisions.
“It’s a bit of a surprise, but the right call,” Avery Shenfeld, chief economist with CIBC World Markets, wrote in an email. “Another rate cut risked a free fall in the exchange rate that could spook consumers. The Canadian dollar is cheap enough to help exporters, and fiscal stimulus (government spending) would be more effective than trying to get house- holds to borrow more than they already have.”
In reaching its decision, the Bank of Canada seemed to be acknowledging Canadians are feeling the short-term pain of a longer-term change in the economy, from a resource-driven powerhouse to greater reliance on non-energy sectors.
From job losses in the oilpatch to higher prices in the grocery store, everyone is feeling the effect of lower oil prices and a rapidly falling Canadian dollar, Poloz said. “It means we have less spending money today than we did before.”
The central bank cut its forecast for the Canadian economy by more than half a percentage point to 1.4 per cent for 2016 and 2.4 per cent in 2017, adding the outlook for demand and potential supply is “highly uncertain.”
The economy “likely stalled in the fourth quarter of 2015, pulled down by temporary softness in the U.S. economy, weaker business investment and several other temporary factors,” the bank also said. Not all the data for the final three months of the year have been reported.
The bank now expects it will take until late 2017 before the economy resumes operating at full capacity, though Ottawa’s spending plans could close the gap earlier.
The Liberal government was elected on a promise to boost spending by $60 billion over the next decade; however, the details of its plans for this year won’t be known until it releases its first budget.
A lower dollar is generally positive for the economy, helping it adjust to lower oil prices by making non-energy exports more competitive, Poloz said, but the adjustment takes time.
The central bank’s forecast focused on early signs exports are improving in non-energy sectors, such as fish and shellfish, packaging materials and medium and heavy trucks and buses.
“I think they are seeing an uptick in some of the economic indicators and they’re heartened by that,” Dawn Desjardins, the deputy chief economist at RBC said. Outside of the energy-dependent provinces, such as Alberta, labour markets and home prices are showing solid growth, she noted.
Canadian manufacturers saw sales rise a better-than-expected-1 percent in November, Statistics Canada said in a separate announcement Wednesday, providing a glimmer of hope to an otherwise gloomy economic picture.
However, some private sector economists said the Bank of Canada’s forecast is still too optimistic and a rate cut is inevitable, in March or April.
Poloz appeared to be trying to “put on a relatively brave face, be a calm voice in the midst of a lot of global turbulence,” Doug Porter, chief economist at BMO Bank of Montreal, said.
“Unfortunately, we suspect that they are still a bit too optimistic on the growth outlook, given the relentless drop in commodity prices and a darkening global backdrop,” Porter added.
Heading into Wednesday’s closely watched announcement, economic forecasters were about evenly split on whether Poloz would cut the benchmark rate to 0.25 per cent, a record low last seen after the financial crisis of 2008-09.
Canadian Manufacturers’ and Exporters, the group most likely to benefit from a lower dollar, also cautioned against a rate cut saying a volatile dollar was hampering business decisions.
The loonie has fallen 17 per cent against the U.S. dollar over the past12 months, to below 70 cents U.S., pulled down by the plunging price of crude oil, the country’s second largest export.