Mark Carney is taking a cautious approach to raising interest rates, weighing Canada's powerful economic rebound against the uncertainty of an "increasingly uneven" recovery across the globe.
The Bank of Canada Governor became the first central banker in the Group of Seven to raise borrowing costs since the financial crisis and recession, increasing the benchmark overnight rate Tuesday by one-quarter of a percentage point to a still exceptionally low 0.5 per cent.
Policy makers will keep an eye on Europe's troubles, and won't move more aggressively than they see fit, the Bank of Canada suggested, even though the economy is rebounding rapidly and inflation will likely exceed its 2-per-cent target this year. Much like in 2008 when the U.S. financial crisis pulled Canada into recession, the country's economic health depends in large part on policy makers in other countries successfully containing homemade problems.
"Interest rates are incredibly low, given the strength of the domestic economy, but the global story is where it's at right now," Eric Lascelles, chief economic strategist at TD Securities in Toronto, said in an interview. "The level of uncertainty suggests there's not a lot of confidence in the forecasts.'' The open-ended nature of the announcement sparked a fall in the Canadian dollar and yields on two-year government bonds as investors pulled back their bets on what they had expected might be a series of uninterrupted rate hikes going forward.
An Investor's Guide to Understanding the Economy by Gary Rabbior:
Still, the central bank said its decision leaves "considerable monetary stimulus in place," and that the effects of Europe's troubles on Canada have been limited to a "modest" drop in commodity prices and somewhat tighter financial conditions.
By comparison, Canada's benchmark rate now matches that of Britain and is only half as much as the European Central Bank's 1 per cent, so there's a lot of ground to cover before borrowing costs are at a level economists consider "neutral." At the same time, even the Reserve Bank of Australia, which started tightening last fall, kept its benchmark rate at 4.5 per cent this week. It, too, cited "various factors" in the world economy that "need to remain under review," among other things.
Should conditions overseas deteriorate - causing banks to curb lending, spooking more investors, snuffing out global growth and crimping Canadian exports - Mr. Carney is reserving the right to take a breather at one of his future decisions, economists said, the next being July 20.
"The picture has become a lot more opaque," observed Stewart Hall, an economist at HSBC Securities in Toronto. "We're basically going meeting by meeting.'' The central bank's statement touched on themes that will be front and centre at the Group of 20 leaders' meeting in Toronto at the end of June, where Canadian officials have said they will be pushing efforts to smooth out the imbalances that exacerbated the slump that much of the world is still clawing out of.
The bank contrasted "strong momentum" in emerging markets with the tepid recoveries in economies such as the United States and Japan that remain "heavily dependent" on low interest rates and government spending, and flagged the possibility of "renewed weakness" in Europe, where the continent's debt problems will likely result in drastic spending cuts and higher borrowing costs.
"In general, broad forces of household, bank and sovereign deleveraging will add to the variability and temper the pace of global growth," policy makers said.
Inflation and the Canadian economy, which on Monday posted a 6.1-per-cent annualized growth rate from January through March, are "unfolding largely as expected," the bank said. But the central bank suggested household spending will slow in the coming months as consumers deal with higher interest rates and try to cut their debt loads. As a result, an "anticipated pickup in business investment will be important for a more balanced recovery," the bank said.
As the cautious and uncertain tone of Mr. Carney's statement suggests, those domestic variables could be dwarfed by a worsening crisis abroad.
The European situation, so far, feels "different than in 2008 because it hasn't corresponded with financial contagion through the banking system," HSBC's Mr. Hall said. "You can expect to see continued market volatility on the ebb and flow of the news stream. That's an accepted reality. What the Bank of Canada won't tolerate, though, is a breakdown in the dissemination of credit, which could bring forward a lot of those nightmarish events that transpired over 2008.''