For months now, the Bank of Canada has been publicly defining its interest rate policy as “data dependent.” The phrase indicated that the central bank’s rate decisions would be guided by what the economic numbers said about the evolution of growth and inflation, taking precedent over the many fears, concerns and uncertainties muddying the outlook.
That changed on Wednesday. “Data dependence” has been superseded by “trade war dependence” at the top of the Bank of Canada’s list of what now dominates its rate-policy thinking.
In its rate-decision announcement, Monetary Policy Report and the prepared opening statement of its quarterly news conference, the bank emphasized its deepening concern about the effects of rising global trade discord, especially the U.S.-China trade war.
In doing so, strongly, repeatedly and in considerable detail, the bank signalled there’s a new sheriff in town when it comes to future rate decisions. Even the bank’s revered economic data, despite its clearly improving trajectory, will be viewed through the wary lens of profound and still-rising trade worries.
The bank even dropped the phrase “data dependent” that had appeared in its previous rate announcement in May, saying instead that it will “monitor incoming data” – a subtle difference, but the kind that gets noticed quickly in central bank circles, where the choice of words in formal communications always matters.
Governor Stephen Poloz himself dismissed the significance of the rewording in his postrelease news conference, admonishing central bank watchers and the financial media not to get too hung up on specific turns of phrase.
“We’re always data dependent. There’s no point in having a particular key phrase repeated or not repeated. It’s just a way of saying that you watch the data carefully – we always do,” he said.
Yet there was a sense that perhaps the governor doth protest too much. Even without the change in wording, the overwhelming weight of the bank’s discussion about its trade worries made plain that trade risks now dominated the policy discussion. The downside risks from trade even appear to have coloured the bank’s updated economic forecasts: Its growth projections for the second half of the year now look considerably more conservative than previous projections, and are well below private-sector forecasts. Why Mr. Poloz would be so reluctant to confirm this shift in priorities, when it was written all over the documents the Bank of Canada published Wednesday is a bit of a mystery.
The governor has dedicated a lot of time and effort in persuading financial market participants to do their own analysis of economic data if they want to get a read on the Bank of Canada’s rate direction, rather than waiting for the bank to spell out its intentions in rate announcements and speeches.
It could be that he would rather not dissuade the markets from a data focus, even if the bank’s own decision-making focus has shifted away from data analysis and toward steering around trade risks. Of course, the two are hardly mutually exclusive – in a smallish, open, trade-intensive economy such as Canada’s, shifting trade winds can affect the economic data quickly and deeply.
Regardless, this new emphasis is right in Mr. Poloz’s long-stated wheelhouse as a central bank chief. Pretty much from day one in the governor’s office, he has described his view of the job as being one of risk management – of weighing the bank’s economic outlook against competing risks that could throw that outlook off course, and guiding interest rate policy accordingly. If anything defines his tenure, it has been this emphasis on risk management – both in the way the bank conducts monetary policy, and in its communications with the public and the markets.
Now, his final year on the job – his term expires next June – looks to be all about managing risk. But there’s a problem. This kind of risk is one that monetary policy is distinctly ill-suited to manage.
As Mr. Poloz and his chief deputy, Carolyn Wilkins, said during their news conference, an all-out global trade war would threaten to simultaneously slow the Canadian economy and drive up inflation (as rising tariffs increase prices while slowing commodity demand weakens the Canadian dollar). In such an event – known as stagflation, which crippled economies in the 1970s – the central bank would be between a rock and a hard place. If it increased rates to fight the surge in inflation – which, its analysis suggested, could be as much as three percentage points in a worst-case scenario – the move would effectively toss an anvil to a sinking economy. If it cut rates to help stimulate the economy, it would pour gasoline on the inflation fire.
As far as risk-management challenges for Mr. Poloz, this could be a doozy. If he can deftly steer policy through the trade uncertainty minefield – while vigilant of the data, but not dictated by it – it may prove to be his greatest achievement.