Prepare for a gap to open between Canadian and U.S. interest rates

The U.S. is primed for higher interest rates, but the Bank of Canada won’t follow suit until there are real policy changes—not just Trump Tweets—to act on

 
Bank of Canada governor Stephen Poloz

Bank of Canada governor Stephen Poloz (Sean Kilpatrick/CP)

They may start teaching Bank of Canada policy statements in school. The vernacular of central banking lacks elegance, but Canada’s policy makers make up for it with brevity. The December 7 statement was a 317 words; the U.S. Federal Reserve used 610 words to explain why it did nothing last month. As I noted earlier this week, little had changed in the Bank of Canada’s world over the past couple of months. It made that point by issuing a press release that would fit inside a Christmas card.

Bank of Canada Governor Stephen Poloz and his deputies on the Governing Council had a few Holiday messages. The most important was that the jump in Canadian borrowing costs has nothing to do with conditions in Canada, in their opinion. “Following the election in the United States, there has been a rapid back-up in global bond yields, partly reflecting market anticipation of fiscal expansion in a US economy that is near full capacity,” the statement said. “Canadian yields have risen significantly in this context.”

President-elect Donald Trump and the Republican majority in Congress are talking about big tax cuts and spending hundreds of billions of dollars on infrastructure. That would boost economic growth, inflation and debt: if the Joy of Cooking contained a recipe for higher interest rates, that would be it. The yield on Canadian 10-year federal government bonds have climbed to about 1.6% from about 1.3% on Election Day. That doesn’t necessarily warrant a response from the Bank of Canada, but the shift is unhelpful. Statistics Canada reported December 6 that imports slumped in October, while exports remained weak. Wall Street’s excitement about the prospect of Trump pushing economic growth to 3% belies the disruption that could come from his promises to make life difficult for America’s trading partners. “Economic data suggest that global economic conditions have strengthened, as the Bank anticipated,” the Bank of Canada said. “However, uncertainty, which has been undermining business confidence and dampening investment in Canada’s major trading partners, remains undiminished.”

Bottom line: the Bank of Canada is unmoved by Trump’s promises, suggesting it will stick to its present course until the president-elect’s Tweets turn into increased demand for Canadian goods and services. Even if Trump and Congress are serious, it will take months to get legislation in place. The sight of bills moving through the legislative process could lift spirits, but it would be 2018 before the multipliers of that spending really kick in. So for now, there is little reason for the Bank of Canada to think about increasing interest rates until at least late next year. That will open a gap between Canadian and U.S. benchmark rates, as the strength of the U.S. economy will force the Fed to raise interest rates. Poloz won’t mind. Higher interest rates would put upward pressure on the U.S. dollar, making Canadian goods and services more competitive. That would be a burden for companies looking to buy American equipment. But it would be great for service providers, who Poloz has identified as the new champions of Canada’s economy.

Canadian and U.S. interest rates tend to follow the same trajectory. Expect the Bank of Canada to remind us often that this time will be different.


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