Rate cut not a magic bullet as economy loses mojo: experts
Feds urged to enhance productivity, lower household debt and slash taxes
TORONTO Looming economic challenges on the horizon including softening business investment, a dip in consumer confidence, and the persistently high household debt-to-income ratio should be sufficient reasons for the Bank of Canada to cut interest rates, economists say.
“We are in the throes of not just a slowdown, but a shift to an economy that has essentially stalled out, even though it might not be a recession in the classical sense of the word,” said David Rosenberg, who now runs his own independent research firm, Rosenberg Research and Associates Inc., and has been bearish on the Canadian economy for some time.
“Lowering interest rates will weaken the Canadian dollar and give a competitive boost to the business sector,” he added.
On Wednesday following the central bank’s decision to hold interest rates steady, governor Stephen Poloz hinted he would consider an interest-rate cut, given weakening economic data across various parts of the economy over the past few months.
The bank also slashed its forecast for fourth-quarter annualized growth to 0.3 per cent from 1.3 per cent in October, and pegged first-quarter growth at 1.3 per cent.
Poloz has so far been a holdout among major central bankers, resisting a rate cut given Canada’s high debt levels, particularly real estate debt that accumulated over the post-crisis decade of low interest rates.
The pace of economic growth in Canada dipped in the third quarter of 2019, due in part to declining exports of non-metallic minerals and agricultural products. But in that same time frame, business investment rose, a key data point for the bank in determining the extent to which monetary levers should be exercised.
Analysts will now be poring over details of retail sales from Statistics Canada on Friday to gauge consumer sentiment.
“Retail sales takes on even more importance tomorrow given the concern about a slowdown in consumption,” Ian Pollick, head of North American rates strategy at Canadian Imperial Bank of Commerce, said in a note to investors, and added that he now believes there is a 75-per-cent chance of a rate cut by the first half of the year. “Specifically, it would appear that the Governing Council remains very concerned that consumption — a pillar of resilience — might be more overtly impacted than initially believed.”
Brett House, Scotiabank’s deputy chief economist, believes that there will be two rate cuts in 2020, but that they won’t set off a new round of borrowing.
“We have been forecasting cuts in 2020 for about seven to eight months now. Much of the borrowing has already taken place this year; that horse has already left the barn. I think if you’re going to see borrowing, it will be from small and medium-sized businesses that want to lower their costs,” said House.
But given that Canada’s interest rate stands at 1.75 per cent, there is less manoeuvring room for the bank, according to Finance Minister Bill Morneau who thinks fiscal policy needs to play a greater role in addressing economic challenges.
“I think we have to be realistic” about expectations of central banks, Morneau said in an interview with Bloomberg TV. “Their ability to be effective in the case of challenges is different than it was in the last real challenge.”
Canada is managing its “fiscal framework very well,” which makes it “resilient in the face of challenges,” Morneau added.
Despite a boost in business investment late last year, Canada is most certainly going to experience slower growth in 2020, especially in sectors that are trade exposed, like manufacturing, says TD’S senior economist Brian Depratto. “Ontario and Quebec, on the manufacturing side, are going to be challenges,” he said.
Depratto also believes that a rate cut in 2020 could be on the horizon, but that it would only serve to solve economic challenges in the short-term.
“Rate cuts create issues down the road. The evolution of debt levels in this country and concerns about financial stability are echoes of past policy decisions. A happier mix would be giving the government a fair bit of spending room where you are not relying just on the household sector to push things forward,” Depratto said.
House points out that prudent fiscal policy on the part of the federal government should involve strategies to not just temporarily stimulate the economy but targeted measures to raise Canadian productivity and lower household debt such that long-term economy growth is sustained.
“There are lots of things the government could do. Increase housing supply in urban areas. Greater spending on affordable child care. Interprovincial trade has to be part of the story as well ... We are the only G7 country with free trade agreements where it is still relatively difficult to trade within our own provinces,” he said.
For Rosenberg, who regards sky-high household debt levels as the biggest problem the Canadian economy is facing, the feds could do just one more thing in tandem with an interest-rate cut: lower taxes.
“The fiscal response should not be increasing spending, it should be broad-based tax cuts that are geared towards low and middle-income households to ease the debt-servicing burden,” he said.
“But here’s the problem with the current government in Ottawa: They think that spending money is going to be the panacea instead of cutting taxes,” Rosenberg added.
Mario Iacobacci, partner at Deloitte’s Economics Advisory Group, was one of the few economists who took a more optimistic view of the state of the economy.
“The reality is, we remain close to full employment and we are operating at capacity in most parts of the country and in most industries. We suspect that the bank will stick to current rates for the rest of the year, because there are no signs of a persistent slowdown yet,” he said.