Governor Stephen Poloz and the Bank of Canada face conflicting signals as they prepare for Wednesday’s interest rate announcement – a pretty decent economy at home, but danger lurking beyond its borders.
A rate cut this week appears unlikely, even as the United States and China threaten an all-out trade war and the risk of a global recession edges higher.
But economists say the central bank will likely start laying the groundwork for a possible cut that could come as early as its Oct. 30 rate announcement.
“The rear-view mirror may be showing a rebound of growth, but the road ahead continues to crumble,” Toronto-Dominion Bank economist Brian DePratto said in a recent research note.
Many analysts expect the Bank of Canada to follow the lead of the U.S. Federal Reserve and other major central banks in embracing a risk-management approach to monetary policy. That could mean pre-emptive rate cuts to ward off the effects of a future recession and rising trade conflict.
This would mark a distinct shift in direction for the Bank of Canada, which has been in a holding pattern for nearly a year after a series of hikes in 2017 and 2018. The bank’s overnight interest stands at 1.75 per cent.
The dilemma facing Mr. Poloz is that a serious escalation of the tariff war between the world’s two largest economies could sideswipe trade-dependent countries such as Canada.
Bank of Nova Scotia economist Derek Holt said the hit to the economy and business confidence could be similar to what happened when the price of oil plunged in 2015.
“We could have a similar dynamic this time around,” explained Mr. Holt, who said the economy may be less resilient to a shock than many people believe.
Scotiabank expects the bank to lower its key rate twice this year – to 1.25 per cent from 1.75 per cent now.
Looking at the data, there’s no obvious case for immediate interest-rate relief. Inflation is right on the central bank’s 2-per-cent target, the economy is growing at a healthy clip, the housing market has bounced back from its lull earlier this year, businesses are hiring and wages are picking up. Unemployment is lower than it’s been in more than four decades.
Statistics Canada reported on Friday that the economy expanded at an annual rate of 3.7 per cent in the second quarter. Canada now has the fastest growing economy among the Group of Seven developed countries.
But that performance is already history. The Bank of Canada is much more focused on where the economy is likely to be a year from now, because it takes a while for the effect of lower rates to ripple through the economy.
And on that front, there is much more for Mr. Poloz and his central bank to fret about. The U.S. and China are poised to escalate their trade war, other key economies are stalling out and the bond market is flashing traditional recession warning signs, with some key long-term interest rates now below shorter-term ones (although not in Canada). There is also the threat of a hard Brexit – one without an agreement between Britain and the European Union – which could dent global business and investor confidence.
The odds of a quarter-percentage-point cut this week by the Bank of Canada remain low, at roughly 10 per cent, according to Bloomberg. But for October, investors are now betting there is a better than six in 10 chance of a rate reduction.
“The real debate will centre on the bank’s decision at the the Oct. 30 meeting,” Bank of Montreal chief economist Douglas Porter said.
If the Bank of Canada does not move then, it could find itself out of line with most other major central banks. Many analysts expect the Fed to cut twice in October. If that happens, Canada would have the highest rate of all major central banks.
Unlike the Fed, Mr. Poloz is not facing overt political pressure to provide rate relief.