Path to higher interest rates looking less certain for the central bank
It will be months before clearer picture emerges, Kevin Carmichael writes.
Stephen Poloz’s creative energy appears to have been restored by the holiday break. Canada’s central bank governor, a noted lover of metaphors and similes, introduced a new array of literary descriptions of how monetary policy works at his first public appearance of 2019.
Finding the neutral rate, or the fuzzy setting at which monetary policy is neither stoking nor impeding economic growth, is like landing a plane on a foggy day: You won’t know you’ve landed until you feel the wheels touch the ground.
Getting to the bottom of what is going on in the Canadian housing market is like downing a foamy beer: It can take some time to work through the froth before you know what you are drinking. And staying ahead of inflation is like making a pass in hockey: You have to anticipate where the play is headed. “Targeting inflation day by day is like aiming at someone’s feet,” Poloz said. The governor makes this look like so much fun that I want to try. Here it goes: Covering the Bank of Canada these days is like taking a road trip with a driver who doesn’t know how long it will take to get to their destination.
“Are we there yet?”
Not yet, the Bank of Canada informed its passengers on Jan. 9.
As expected, the central bank left the benchmark interest rate unchanged at 1.75 per cent. Less expected was a heightened expression of concern over the housing market and the ability of debt-burdened households to manage higher interest rates. Those factors, combined with the negative effects of lower oil prices and U.S. President Donald Trump’s trade wars, have created a headwind that has forced the Bank of Canada off a direct path to higher interest rates. “Governing Council continues to judge that the policy interest rate will need to rise over time into a neutral range,” which is thought to be between 2.5 per cent and 3.5 per cent, the central bank said in its new policy statement. “The appropriate pace of rate increases will depend on how the outlook evolves, with a particular focus on developments in oil markets, the Canadian housing market, and global trade policy.” Policy-makers also opted against raising interest rates in December, while advising that significantly weaker oil prices threatened the economic outlook. The warning came true. The Bank of Canada’s quarterly update of its forecasts found that the economy has run into a soft patch that could last for at least a couple of quarters. Policy-makers cut their estimate for economic growth in 2019 to 1.7 per cent from 2.1 per cent in October. That’s slower than the economy’s non-inflationary speed limit, suggesting that the trip to the neutral rate, which Poloz describes as “home,” will require more time than previously advertised.
“There is no question in our minds that the economy is on solid footing,” Poloz said at a press conference in Ottawa. However, “we are less close to home than we thought three months ago,” he said.
Just how much less is now the subject of rather good debate on Bay Street. Economists at Bank of Nova Scotia, Royal Bank of Canada and Laurentian Bank are among a group that thinks the economy will get back on track relatively quickly, prompting the central bank to raise interest rates two or three times before the year is over. Almost as many analysts and investors struggle to see what would trigger a re-acceleration of growth. Economists at National Bank said interest rates are on hold until at least the second half, and Canadian Imperial Bank of Commerce’s Avery Shenfeld was ever more downbeat. If the current headwinds blow through midyear, the October federal election will become a factor, as the risk of becoming a focal point in the campaign would join the list of variables that policy-makers would have to weigh.
All of this assumes one agrees that the Canadian economy is as fundamentally sound as a historically low jobless rate implies. Not everyone is convinced about that. Some bond traders think the Bank of Canada could be forced to cut interest rates before it gets a chance to raise them again. Darcy Briggs, a senior executive and portfolio manager at Franklin Bissett Investment Management, was struggling to square the Bank of Canada’s forecast of export growth that is stronger than “recent historical experience” with its worries over what Trump’s trade wars are doing to global commerce. “It’s a bridge too far,” Briggs told me in a telephone interview from Calgary. “We’re in the midst of a global economic slowdown, not a pickup,” he said.
The Bank of Canada might counter that slower global demand doesn’t mean no demand. It is counting on Enbridge Inc.’s Line 3 pipeline and an increase in the number of rail cars hauling oil to get more crude to market in 2019. New trade agreements with the European Union and Pacific nations also should boost revenue from abroad. The opportunity to tap new markets, paired with the imperative to retool to keep pace in a digitized economy, should prompt “robust” business investment outside the oil industry, according to the central bank’s new forecast.
One thing to keep in mind: If the central bank is right, and Briggs is wrong, all that investment could expand the Canadian economy’s ability to grow without causing inflation. So the pessimists and the optimists have something in common. Both agree that we’re not home yet and that it will be months before we know more about when we will get there.