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Federal Reserve Chairman Ben Bernanke. (J. Scott Applewhite)
Federal Reserve Chairman Ben Bernanke. (J. Scott Applewhite)

Opinion

Why central banks should not raise rates Add to ...

Whenever there is a presumed "asset bubble," speculation about interest rate hikes starts up, economists Derek Holt and Karen Cordes of Scotia Capital Inc. said in a research note Tuesday.

"That's the message the hawks are delivering: Asset bubbles, some perhaps clearer than others, should be pricked by fairly aggressive rate hikes," the Scotia Capital team wrote.

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The Federal Reserve Board in the United States is holding its benchmark interest rate at near zero, and the Bank of Canada committed to holding its rate at 0.25 per cent until well into next year.

Mr. Holt and Ms. Cordes list six reasons why the central banks should resist pressure to raise rates on asset bubble fears. In their words:

Borrowing still weak

Big pricing improvements can occur alongside zero money demand. Such a liquidity trap is the current conundrum facing the Fed. As the risk trades have gone vertical, low borrowing costs have not sparked renewed borrowing.

Households and businesses in the U.S. are paying down debt.

Households in Canada are still borrowing, but business borrowing is tanking this year. Until evidence of a material pick-up in money demand becomes more apparent, the baseline expectation should remain that asset markets will be disappointed by longer run growth expectations.

Leverage 'still largely absent'

Leverage is still largely absent. That's key to a central bank. If the mistakes of the past monetary cycle are to be repeated, then it must in large part be because leverage is returning. Yet the evidence and anecdotes are light in that regard. A one-month spike in loan-to-value ratios for mortgages approved at US mortgage loan companies in July gave way to a renewed drop in August. Mortgage loan companies were the thin edge of the wedge the last time around before higher loan leverage crept into the core banking system, but they remain much more cautious this time around. Further, the shadow banking products remain light.

Bubbles need time to 'determine their sticking power'

Real or presumed asset bubbles must be given enough time to determine their sticking power and it's premature to judge this from a monetary policy standpoint. It's not difficult to see a risk aversion trade unfolding, yet monetary policy wouldn't desire to make it worse by hiking prematurely in comparison to the fundamentals.

Only broad-based inflation would justify rate hikes at this point

There must be a reasonably broad-based reason for inflation to break out. Rising house prices in Canada (hardly the U.S.) in the absence of broader price pressures is a relative price shock. It is not generalized inflation. Inflation targeting central banks like the Bank of Canada don't target relative prices, and monetary policy isn't the best tool for doing so anyway.

There's no bubble in 'Leave-it-to-Beaver' single family homes

It's said there's a bubble in Canadian housing. We're not convinced. A bubble usually implies a growing stockpile of unsold product. That's not the case for the Leave-it-to-Beaver two-storey two-car garage benchmark. In fact, inventories of single family homes are dropping and sit at lean levels. Condo inventories are at their highest since the first part of the 1990s, but fairly narrowly based in Toronto, Vancouver and Calgary.

Rate increase would strengthen already high loonie

The Bank of Canada, until 2011, is a strict inflation targeting central bank under its current agreement with the Federal Government. The debate over what should be targeted thereafter is unsettled, but it's odd for a part of the market to be talking rate hikes while both the Governor of the Bank of Canada and Finance Minister are concerned about the Canadian dollar and talking up their options.

 

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