Bank of Canada leaves door open to rate cut as concerns of weak inflation grow

By Gordon Isfeld, The Financial Post, January 23, 2014 - OTTAWA - Canada’s economy is expected to tag along with the stronger U.S. recovery as it picks up speed — but, for now, it could be a matter of hurry up and wait. Inflation in this country needs to get back to the Bank of Canada’s 2% target, and policymakers don’t expect that to happen for couple of years.

That’s good for consumers in general, but not the economy as a whole — and certainly not for a hot housing market and record household debt levels.

The loonie is at a more than four-year low, falling almost a penny Wednesday, helping manufacturers and exporters compete a little more aggressively — but chipping away at the buying power Canadian shoppers had enjoyed south of the border.

The central bank’s trendsetting lending rate has been stuck in a rut for nearly 3.5 years, with its eventual course still to be determined.

Canada governor Stephen Poloz acknowledged all this on Wednesday, as he announced that the bank’s key rate will be staying put at 1%, where it has idled since September 2010.

“The timing and direction of the next change to the policy rate will depend on how new information influences this balance of risks,” he told reporters in Ottawa.

That comment echoed the so-called neutral policy stance taken by Mr. Poloz in March, moving away from the bank’s long-held position — first taken by the previous governor, Mark Carney — that maintained any adjustment to rates would be upwards, leading to speculation that the next move could be to the downside.


Since the policy shift, the Canadian dollar has fallen to just above US90¢, which could act as a de facto rate cut by making our products cheaper to purchase outside the country.

But Mr. Poloz, 58, said consistently weak inflation remained the biggest concern for policymakers, and the reason for those smaller price gains is also troubling.

“This is due largely to significant excess supply in the economy and heightened competition in the retail sector,” he said.

Canada’s rate of inflation has been below 1% for seven of the past 12 months. The next reading on consumer prices will come Friday, when Statistics Canada releases its December data.

“The path for inflation is now expected to be lower than previously anticipated for most of the projection period,” Mr. Poloz said.

The bank expects inflation to return to the 2% target in two years or so, as the effects of retail competition dissipate and excess capacity is absorbed.

Right now, however, “the downside risks to inflation have grown in importance,” he added.

“At the same time, risks associated with elevated household imbalances have not materially changed.”

In recent days, three of Canada’s biggest commercial lenders — Bank of Montreal, Bank of Nova Scotia and TD Canada Trust — have lowered their five-year fixed mortgage rates by between 10 and 20 basis point. This has renewed concern that more consumers will pile into the housing market just as analysts are anticipating a soft landing for the sector.

Mr. Poloz told reporters “it’s not the Bank of Canada’s job minutely to try to influence these things in an independent way.”

“Mortgage rates are driven by [bond] market rates, not by the Bank of Canada.”

Meanwhile, the bank on Wednesday adjusted its economic growth outlook from the previous forecasts issued in December.

In its quarterly Monetary Policy Report, released along with the bank rate decision, the bank raised its growth estimate for 2014 to 2.5% from 2.3%, but lowered next year’s prediction to 2.5% from 2.6%.

Canada’s economy grew by just 1.8% in 2013, a disappointing performance after what had been a strong initial rebound from the 2008-09 recession. Employment growth had also been impressive coming out of the downturn, but that, too, has been underperforming since last year.

“The U.S. recovery is becoming more broad-based, including higher investment spending by companies, and that, as well as the recent depreciation of the Canadian dollar, should help to boost exports,” Mr. Poloz told reporters.

“This, in turn, should lead to stronger business confidence and investment here in Canada.”

The governor, pushed to elaborate on the impact of the weak dollar, said “the economy is globalized. Companies have, in effect, naturally hedged themselves a bit more with imports in their supply chain. So, the effect is less.

“As I see it, the increase in U.S. demand is the most important thing. That’s the cake. And if the exchange rate is going down a little, and gives us a little bit of a marginal boost, there’s the icing on the cake.”

Douglas Porter, chief economist at BMO Capital Markets, said the bank “found a way to maintain its mostly neutral stance, sound a bit more upbeat on the global outlook, modestly upgrade its Canadian growth outlook, and yet still keep the downward pressure squarely on the Canadian dollar.”

“Their elevation of too-low inflation risks — which [Mr.] Poloz has highlighted before — and the direct comment on the currency did the trick,” he said.

“Suffice it to say that the bank is welcoming the weakening Canadian dollar with open arms, partly because it in turn reduces the pressure to consider trimming interest rates since the lower currency will begin to pump some life into inflation.”

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