Bank of Canada Governor Mark Carney is a proponent of tough love.
When he took over the central bank, financial markets were used to being told where to go. Mr. Carney refused to go along.
Policy makers lack perfect foresight, and shouldn’t pretend otherwise, he argued. Financial stability was best served by a healthy debate among market participants about the prospects for the economy and policy. Mr. Carney wanted analysts to study economic indicators, not tea leaves. That way, if things go off the rails, it’s less likely that everyone will end up crushed by the wreckage.
As he nears the end of his tenure at the Bank of Canada, Mr. Carney finally is getting his wish. There is a serious debate in financial markets over whether the central bank will change course Wednesday when it releases its latest policy decision at 10 a.m. Toronto time.
For Carl Weinberg, chief economist at High Frequency Economics, a research firm based in Valhalla, N.Y., the choice is clear. Inflation is running at the bottom of the range that Canada deems acceptable, the economy almost stalled in the fourth quarter, factory shipments “dropped like a stone” in December, the housing bubble is deflating, and fiscal policy is focused on deficit reduction.
“Is this not a perfect situation for easier monetary conditions?” Mr. Weinberg asked, rhetorically, in his daily note to clients on Tuesday.
Crazy talk, right? If so, Mr. Weinberg isn’t alone at the asylum. Prices for financial assets tied to the Bank of Canada’s benchmark interest rate suggest some investors are at least hedging against the possibility of lower borrowing costs.
According to Jimmy Jean, an economic strategist at Desjardins Capital Markets in Montreal, the yield on overnight index swaps suggest a 30 per cent probability that Mr. Carney will cut interest rates Wednesday, compared with almost zero probability in January. The Canadian dollar’s 3-cent drop against the U.S. dollar – to about 97 cents from par – since the Bank of Canada released its last economic outlook is another indicator that investors are beginning to rethink the notion that the Bank of Canada’s next move would be to raise interest rates.
This isn’t the majority view.
Scotia Capital’s Derek Holt warned his clients Tuesday against reading too much into the market shifts, saying the Canadian dollar could rally a bit Wednesday after the Bank of Canada surprises the rate-cut theorists by changing its policy stance only slightly.
There’s no question Canada’s economy has hit a soft patch. But there is a question about whether policy makers should panic.
Mr. Carney acknowledged last week that indicators are weaker than the central bank had forecast. At the same time, he said he remained comfortable with the inflation outlook, which is significant, since the Bank of Canada sets policy by targeting inflation. It would be a step too far, even for Mr. Carney, to signal relative comfort with the Bank’s outlook one week, and then cut interest rates the next.
The central bank quite likely will rewrite its policy statement to reflect a weaker economy – but perhaps not that much. Sébastien Lavoie, assistant chief economist at Laurentian Bank in Montreal, anticipates a “mildly dovish” readout from the central bank, meaning policy makers could take a baby step back from their tilt toward raising interest rates.
Given the Canadian economy has that crashing feeling, it’s reasonable to ask why the central bank would stand idly by. The reason is that the Bank of Canada already is extremely “dovish.” Policy makers in January acknowledged weaker economic conditions had made higher borrowing costs “less imminent than previously anticipated.” And their bias toward raising interest rates hardly is aggressive. They promise only to do so only modestly, and “over time,” consistent with the 2-per-cent inflation target. There’s plenty of wiggle room there to leave interest rates low for a long time. The betting on Bay Street is that the central bank will do nothing until 2014.
The last thing to keep in mind that the Bank of Canada has been warning about higher interest rates as a way of leaning against a housing boom that Mr. Carney and others think threatens financial stability. Mr. Carney last week said that he thinks the growth of household debt has slowed to the same pace as income growth, representing the “verge” of stability.
Mr. Carney surely will want to achieve stability before he lets up his campaign against the perils of record levels of debt. That makes Wednesday too soon to set a dramatically new course. But that doesn’t mean it isn’t coming later. The winds have shifted.