It looms permanently in the distance – the interest rate hike that threatens to squeeze household budgets and trigger a housing slump.
The Bank of Canada has been non-committal on the timing of any tightening to monetary policy, only allowing that “a gradual normalization of policy interest rates can … be expected.”
That guidance is unlikely to change on Wednesday when the central bank makes a policy announcement. Nor is a change to the targeted overnight rate likely, which the Bank of Canada has maintained at 1 per cent for three years now.
“When the world is swirling around you, stay the course,” said Michael Gregory, senior economist at BMO Nesbitt Burns.
Bank of Canada Governor Stephen Poloz should be spurred to inaction by competing economic forces. While confidence in some emerging markets has crumbled, most of the G7 countries are starting to look up. Meanwhile, Canada’s economic fortunes seem to be fading, but the United States looks destined to emerge from its stagnant post-recession era. Even U.S. strength is a double-edged sword, improving Canada’s export outlook, but putting pressure on indebted Canadians through rising long-term interest rates.
At the moment, the Bank of Canada is inclined to accentuate the positive.
“The improving underlying strength of the U.S. economy should more than compensate for the drag from higher interest rates,” Bank of Canada Deputy Governor John Murray said last week in a speech.
Others aren’t so sure. “Our suspicion … is that higher mortgage rates will wreak havoc in Canada’s housing market, eventually prompting the Bank to become more pro-active,” Paul Ashworth, chief North America economist at Capital Economics, said in a note. “When the Bank of Canada eventually realizes that exports aren’t going to offset the increasing weakness in domestic demand, we would expect a shift in thinking.”
For now, Mr. Poloz is expected to cling to the current tightening bias, if only for persistent worries about Canadian indebtedness, which has resumed accumulating after abating in the first quarter.
In fact, the recent rise in long-term lending rates provides a disincentive to further borrowing. Fixed mortgage rates in Canada have risen over the past few months, ever since the U.S. Federal Reserve began hinting at reducing or tapering off the scope of its bond-buying program.
“This does some of the job for the Bank of Canada,” Mr. Gregory said. “So, just sit back and let it work.”
Even if Mr. Poloz is concerned about the Canadian downside of Fed tapering, the July Monetary Policy Update attributed some of the recent bond selloff to “short-term volatility and overshooting,” offering further evidence that the Bank of Canada is not likely to budge from its policy bias.
Expect rate hikes to continue to “be expected.”
“We’re getting closer and closer to that time,” Mr. Gregory said. “It still may be a year or more away, but it’s a sign that that bias is not going to go away.”
In addition to the U.S. resurgence, there are other global signs of improvement giving Mr. Poloz the luxury of time, said Mark Chandler, head of Canadian fixed-income strategy at RBC Dominion Securities. Commodity prices are stable, oil prices in particular are high, and even the euro zone is gathering itself, having emerged in the second quarter from an 18-month contraction. “There’s no pressure on him to make any changes in the near term,” Mr. Chandler said. “He’s got a free card to sit and wait.”