It sure feels like the Bank of Canada is going to cut borrowing costs this week. The negatives outweigh the positives in the economy, and we know based on 2015 that Stephen Poloz’s Governing Council puts a greater emphasis on the here-and-now than it does on the theoretical threat posed by a near-zero interest rate. By the late morning Eastern time on January 20, the central bank’s benchmark could be 0.25%, matching the record low set during the financial crisis.
Analysts are split on what the Bank of Canada will do with its first policy announcement of 2016. Mark Chandler of RBC Dominion Securities predicts Poloz will opt to leave interest rates unchanged, but says he has a lot of time for those forecasting a cut. Douglas Porter and Avery Shenfeld, the top economists and Bank of Montreal and Canadian Imperial Bank of Commerce, respectively, say they think the central bank will drop the benchmark rate a quarter point. They also say doing so will be a mistake. Prices for credit assets tied to the Bank of Canada’s target imply traders think there is a 60% chance that Poloz will once again be moved to respond to persistent economic weakness.
In July, when the Bank of Canada cut its policy to its current setting of 0.5%, policy makers expressed concern over weak non-energy exports and a deep contraction in business investment brought on by the collapse of commodity prices. Yet they believed the worst would pass by year’s end, predicting economic growth at an annual rate of around 2% in the fourth quarter. The world hasn’t evolved that way, which is why further stimulus is a possibility. Non-energy exports showed life over the later half of 2015, as the U.S. economy powered out of a moderate slump at the start of last year. But business investment remains a problem. The Bank of Canada’s latest quarterly Business Outlook Survey showed that executives have no intention of spending any more money on machinery and equipment this year than they did in 2015.
That’s mostly due to ongoing decline of the value of oil, the international price of which dropped below $30 (US) per barrel last week. In October, when the Bank of Canada last released an economic outlook, policy makers assumed crude prices would hold closer to $50 per barrel. Other commodity markets are behaving similarly because there is more supply than a sluggish global economy can absorb. Charles St-Arnaud, a former Bank of Canada economist who now works at the Japanese bank Nomura in London, reckons Canada’s economy grew little in the fourth quarter. Canada’s central bank will release revised economic forecasts this week. If they look like those of St-Arnaud, then Poloz will have all the information he needs to justify additional stimulus.
An argument against cutting interest rates is the twin housing bubbles of Toronto and Vancouver. However, Poloz hasn’t appeared overly fearful of triggering a financial crisis, arguing that lower interest rates will help to avoid one by making it easier for homeowners to keep up with their mortgage payments. The stricter mortgage rules announced by Ottawa last autumn also should allow the central bank to worry less about the housing market. Stimulus help is coming by way of Prime Minister Justin Trudeau’s infrastructure program, which some analysts offer as a reason to avoid an interest-rate cut, or at least delay one. But it could be several months before federal money makes a significant addition to gross domestic product. St-Arnaud said an interest-rate cut would buy a little time while the federal government gets its programs in place.
Perhaps the best reason to leave interest rates unchanged is uncertainty over what would happen to the value of the Canadian dollar. The country’s currency slid below 70 U.S. cents last week, causing some to recall early 2002, when Canadian officials were forced to beg international investors to recognize that the inherent value of Canada’s currency was greater than 63 US cents, the record low to which it had fallen at the time.
Porter and Shenfeld said Canada’s currency has fallen enough to spark a revival of exports; another interest-rate cut risks volatility and inflicting harm on aspects of the economy that rely on imports. Jayson Meyers, the head of Canada’s main exporters’ lobby and an economist by training, told Bloomberg News that the Bank of Canada should consider raising interest rates, not lowering them. “A little bit of dollar stability would be better,” he said. For years, agencies such as the Export Development Canada have been encouraging companies to insert themselves into global supply chains by investing abroad. A weaker currency makes that more expensive, depending on the country. And an exchange that drops 16% in a year, as the Canadian dollar did in 2015, makes budgeting difficult.
The currency is a valid issue. But it’s noteworthy that Porter and Shenfeld separated their own views from what they anticipate the Bank of Canada will do this week. The central bank has offered nothing that would suggest it is at all bothered by a weak dollar. Poloz says the only rate he cares about is inflation, and virtually every piece of official communication from the central bank notes the boost that non-energy exports are getting from the weaker exchange rate. A lower dollar also softens the blow of the commodity crash by increasing the value of sales priced is the U.S. currency. It is possible the Bank of Canada believes the 70-cent dollar may be keeping some energy companies from going bust.
Bottom line is that if the intervention was justified in July, it is likely justified now. Another thing to keep in mind is that the central bank always can use more explicit language to describe its intentions if it is worried that currency traders could overreact to an interest-rate cut. Poloz says such guidance only should be used in extreme circumstances, such as when it is running out of room to cut interest rates. The Bank of Canada soon could enter a zone where forward guidance is entirely appropriate.
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