There was some commotion after the Bank of Canada’s last policy announcement. A good number of the central bank’s closest observers over-interpreted the October 19 interest-rate statement and Governor Stephen Poloz’s prepared remarks to reporters, which he and Senior Deputy Governor Carolyn Wilkins use to provide context. Poloz revealed the committee “actively discussed” lowering interest rates, which caught some off guard. The dollar went for a tumble, and flat-footed analysts were unhappy about it.
It should be smoother this week. The Bank of Canada will make its last scheduled policy decision of 2016 on December 7. There will be no press conference, so no additional verbiage for market participants to digest: just a simple statement of around 400 words. For the central bank, nothing much has changed in the past six weeks. That may sound odd given recent events, but the election of Donald Trump will have had little impact on the Bank of Canada’s deliberations. Poloz, Wilkins and the other members of Governing Council will have concerned themselves with what the latest data say about the future course of inflation. Those indicators suggest the economy is about where the central bank thought it would be at the end of 2016. Trump could eventually have a dramatic effect on Canada’s prospects. However, inauguration still is more than a month away. As Poloz has said numerous times, the Bank of Canada doesn’t make decisions based on hypothetical scenarios.
But Wall Street and Bay Street surely do. Stock markets in the U.S. jumped to record levels after the election, as investors bet Trump and the Republican majority in Congress will team up to slash corporate taxes and spend billions on infrastructure. The post-election consensus has altered financial conditions in North America. Trump’s policies would bring faster economic growth, higher inflation, and more debt. With the U.S. unemployment rate at a near-decade low of 4.6%, there is now little reason for the Federal Reserve to resist raising interest rates. Bond traders already have pushed yields on American debt higher in anticipation of the shift in Fed policy.
Canadian borrowing costs also have jumped. On Election Day, the yield on 10-year Canadian government bonds was 1.27%, according to Bank of Canada data. On December 2, the yield was 1.63%. That’s still very low by historical standards. But it is possible businesses and households have reset their expectations based on the post-crisis era of zero interest rates. If they have, the November surge in borrowing costs might have derailed spending plans.
Poloz likely decided to state explicitly that the central bank had considered stimulus to make sure the public understood that Canada’s economic prospects had weakened, and that central bank therefore could be forced to do something about it. (The prices of financial assets tied to the Bank of Canada’s benchmark rate suggested there was almost no expectation of an interest-rate cut.) The jump in Canadian borrowing costs may prompt the central bank to send another reminder that higher interest rates are out of sync with a weaker outlook. The economy’s acceleration to annualized growth of 3.5% in the third quarter wasn’t a game changer. The Bank of Canada saw that coming—and it is fairly convinced that the momentum won’t last. Statistics Canada also reported last week that business investment continued to fall, and (in a separate release) that Canada is on track to create more part-time jobs than full-time positions in 2016. Neither of those are markers of a thriving economy.
One of the reasons the Bank of Canada opted against stimulus in October was that the economy’s trajectory was unusually difficult to predict. One vulnerability had diminished. The central bank stated that tighter restrictions on mortgage lending reduced the threat of a housing bust. Higher interest rates also will minimize that threat. But the outlook for the economy remains just as uncertain. That’s mostly because of Trump. The OECD said last week that tax cuts and spending will lead to annual growth of 3% in 2018, double the rate of the past decade. That would be great for Canada. But Trump might also blow up the North American Free Trade Agreement and ensure infrastructure spending favours American companies. That would be bad for Canada.
Until Trump shows whether he will be a positive or negative for Canadian companies, the Bank of Canada has little choice but to stay neutral.
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