The Bank of Canada acknowledges it’s “surprised” by how abruptly the economy is decelerating, particularly as Canadians curb their spending on such things as cars, home renovations and foreign vacations.
A top official laid out a detailed explanation Thursday for why the central bank is now seriously rethinking its plan to keep raising interest rates. The shift stems from what happened in the fourth quarter, when Canada’s gross domestic product grew at a paltry 0.4-per-cent annual pace, deputy governor Lynn Patterson said in a speech to the Chamber of Commerce in Hamilton.
“Although we figured the economy was in for a detour at the end of last year, that detour may end up being longer than we had expected,” Ms. Patterson said.
Nonetheless, she said the bank still expects the economy to “pick up” later in the year, buoyed by growth in jobs and wages.
Bank of Canada officials initially thought the slowdown would be confined to the oil sector, which was hit hard last year by a sudden price slump and pipeline bottlenecks. Instead, virtually all the key components of GDP showed evidence of weakness – from exports and business investment to consumer spending, which makes up more than half the economy.
“While the anticipated slowdown from the energy sector was fairly aligned with our projections, other categories surprised us,” Ms. Patterson said.
On Wednesday, the Bank of Canada kept its benchmark rate unchanged at 1.75 per cent and warned that Canada’s economy will be significantly weaker in the first half of 2019 than it forecast just two months ago. The shift in tone moves the bank one step closer to shelving the option of higher rates after five hikes since mid-2017.
Many economists now don’t expect the bank to hike again this year.
Speaking to reporters, Ms. Patterson said any move to roll back its bias toward hiking again will depend on incoming economic data as the bank prepares for its next rate decision on April 24. “At this point, we are looking to see whether some of that [economic] weakness is temporary or it’s more persistent, and we’re going to need more data before we can assess that,” she said.
Among the key surprises for the bank is how consumers are reacting to such factors as higher borrowing costs, the “wealth effect” of the cooling housing market and the slowing growth of disposable income. All of that, she said, is causing Canadians “to be more cautious about their spending.” Ms. Patterson said consumers are cutting back on all sorts of discretionary spending, including new cars, restaurant meals, renovations and foreign vacations.
“It is in these categories that we are seeing shifts in spending habits,” Ms. Patterson said.
Sales of new cars, for example, fell 1.7 per cent in 2018 from a year earlier. Spending on entertainment and restaurant meals grew just 1 per cent last year, compared with 2017, which saw 3-per-cent growth.
Nor is the economy getting any help from exports and business investment, which continue to be sluggish. Ms. Patterson said both are being dragged down by a combination of a slowing global economy and continuing trade tensions, particularly between the United States and China. Companies may be delaying investments in the face of uncertainty over U.S. trade policy, ratification of the U.S.-Mexico-Canada trade agreement, and U.S. steel and aluminum tariffs, she said.
“Global concerns ... are clearly hurting confidence and leading firms to delay investment decisions,” she said.
Another reason companies aren’t spending may be because they are waiting for recently announced federal accelerated-depreciation tax breaks on new investments to kick in.
Ms. Patterson said the bank may need to revise its estimate of the neutral interest rate – the level where interest rates neither perk up, nor slow down, the economy – at its next rate decision in April. The current range is 2.5 per cent to 3.5 per cent, or significantly higher than the bank’s benchmark rate. Lowering the neutral rate would imply the benchmark rate is already close to neutral.
In a research note Thursday, Gluskin Sheff chief economist David Rosenberg said the bank’s neutral rate may actually be less than 2 per cent, which means “the process of normalizing rates may well have already happened.”