The Bank of Canada put on hold plans to raise its key interest rate in the face of a gloomier economic outlook and stubbornly low inflation.
Bank of Canada governor Stephen Poloz jettisoned a Mark Carney-era pledge Wednesday to begin ratcheting up ultra-low interest rates, which had been a fixture of the central bank’s policy statements dating back to early 2012. Mr. Poloz, who took over from Mr. Carney in June, is as close to a rate cut, if economic conditions worsen, as he is to an increase.
The surprise decision to drop the so-called tightening bias – in place since April, 2012 – coincides with a significant downgrade of the bank’s forecast for economic growth in Canada in 2013 and beyond. It also suggests that Canada, like the U.S. and other major economies, has further to go before the government can declare that the country has recovered from the financial crisis that began five years ago.
The prospect of an extended period of low rates draws out the pain in Canada’s financial sector, where pension funds, insurers and banks have been hoping for wider margins. This also complicates the government’s efforts to curb prices in the housing sector, where investors have flocked in recent years. Mr. Poloz’s comments reflected the uncertainty. Pointing out that monetary policy is more about managing ever-changing risks than engineering specific outcomes, the central banker said he wants to be more open about how the bank plots its interest rate decisions.
“We’re trying to be totally transparent and honest,” Mr. Poloz told reporters in Ottawa. “We’re never going to tell you exactly what it takes because that’s an answer we just don’t have.”
The bank left its overnight interest rate unchanged at 1 per cent, where it’s been since September, 2010. Its next rate-setting decision is Dec. 4.
Bank of Canada’s new assessment sent the Canadian dollar tumbling as investors reacted to the prospect that interest rates could stay low for a lot longer than anticipated. Many economists now don’t expect the central bank to raise its key rate until late 2015, or even 2016.
“This will delay any prospective rate-hiking campaign,” Bank of Montreal economist Michael Gregory said in a research note. “Policy rates could end up being lower for a lot longer.”
Mr. Poloz’s change of course spares the Bank of Canada from promises it can’t keep and puts the focus back on the bank’s two per cent inflation target, argued Finn Poschmann, vice-president of research at the C.D. Howe Institute in Toronto. He pointed out that both the U.S. Federal Reserve and the Bank of England have recently fallen into the trap of promising too much by tying rate hikes to specific unemployment targets, he suggested.
“I think this is the right course,” Mr. Poschmann said. “Life is tough enough without having to guess at what the bank will do, and whether it will, or can, deliver on what it says it will do.”
On the economy, the central bank pointed an economic environment that is now “less favourable for Canada,” including a slow recovery from recession in the United States, Canada’s main trading partner. And that is delaying a pick-up in exports and business investment, the bank said.
Canada’s export dilemma is that it is still far too dependent on the U.S., which is grappling with a sluggish recovery and poisoned budget politics in Washington, and underexposed to fast-growing emerging markets.
The Bank of Canada had anticipated that exports and business investment would pick up as the consumer-driven domestic economy cooled, along with the housing market. But that isn’t happening. Instead, business confidence remains weak and exports are failing to regain pre-recession levels.
That means the economy isn’t likely to return to “full production capacity” until the end of 2015, according to the bank, keeping inflation below its explicit 2 per cent target. The bank had previously estimated that the so-called output gap would close by mid-2015.
The bank also fretted about that continued low interest rates increase the risk of a housing correction.
In its quarterly monetary policy report, also released Wednesday, the bank said the export sector has been “lacklustre” in the second and third quarter, with the exception of autos and forest products. In August, Canada posted a 20th consecutive monthly trade deficit, dragging down GDP growth. And while exports to the U.S. rose 1.9 per cent to $30.1-billion, Canada’s share of the U.S. market has been on a steady downward slide since 2000.
Speaking to reporters, Mr. Poloz said the high dollar is not the “most important thing” harming exporters. He pointed out that roughly 9,000 exporting businesses have vanished since the recession.
The bank also blamed “shifts in trade linkages” and “ongoing competitive challenges.”