The Bank of Canada says the unexpected strength of the domestic economy and the fact that inflation is right where it should be were the main reasons it kept interest rates unchanged this week.
In a speech delivered one day after the bank announced that its key interest rate would remain at 1.75 per cent, Lawrence Schembri, a deputy governor of the bank, said the Canadian economy has enough momentum to weather a potential slowdown caused by global trade tensions.
Providing a window into the bank’s recent internal discussions, Mr. Schembri said the rate decision was influenced by data that show the Canadian economy is operating close to full potential, the unemployment rate is near historic lows and inflation is at the bank’s target rate of 2 per cent.
“The economy has clearly gotten past its earlier soft patch,” he said in reference to strong second-quarter gains after a sluggish first quarter. “The solid starting point means the economy has a welcome degree of resilience to possible negative economic developments. That said, we agree that the data show some areas of concern.”
He mentioned weak consumption, a drop in business investment and the trade war between the United States and China as the main challenges.
The speech to the Halifax Regional Chamber of Commerce is the last scheduled public statement from the Bank of Canada before the Oct. 21 federal election. Like most of the federal public service, the central bank generally keeps a low profile during election campaigns.
Analysts had been looking to this speech for signs of whether the central bank intends to reduce rates later in the year to stimulate the economy, after Bank of Canada Governor Stephen Poloz did not provide any such guidance after Wednesday’s rate announcement.
Thursday’s speech did not indicate explicitly where the bank is leaning in terms of future rate decisions. The bank’s next rate decision will be released on Oct. 30, along with its quarterly monetary policy report.
Mr. Schembri later told reporters the bank’s analysis of the data and global events that materialize over the coming weeks will determine its October decision. For now, he said the bank believes the current rate is appropriate.
“I think it provides sufficient stimulus to the Canadian economy to offset some of the dampening effects from the global trade war," he said.
In his speech, Mr. Schembri had highlighted the fact that Canada’s current key lending rate is a half percentage point below that of the United States.
While the bank had been widely expected to keep the rate unchanged this week, many economists had thought it would cut rates later this year and possibly as soon as October. The general reaction from economists this week is that the bank’s comments are less pessimistic than expected and the odds of an October cut have decreased.
The argument for a rate cut this year would be to soften the negative shocks to the economy that could result from the trade war between Canada’s two largest trading partners.
Queen’s University economist Thorsten Koeppl said the bank is right to wait for clear data. Mr. Koeppl said he is not a fan of pre-emptive rate cuts as a form of insurance against a future downturn, but he does expect the global economic risks to materialize and force the bank to cut rates.
“I just have a very pessimistic outlook because there’s so many risk factors right now,” he said in an interview. “There’s going to be a big impact. I’m not expecting that nothing happens, but if nothing materializes, I think the bank is perfectly well positioned with 1.75 [per cent.]”
University of Quebec at Montreal economist Steve Ambler said the bank faces two possible scenarios.
“If we get lucky, China and the U.S. are going to sit down and actually put an end to this silly trade war – or they’re not,” he said. “With the pessimistic scenario, I think we are going to be looking at significant rate cuts around the world, and Canada is certainly going to be following.”
Mr. Ambler said the bank will also face pressure to respond should the U.S. Federal Reserve cut its rate again later this month.
“It’s really going to hinge a lot on what the Fed does in another couple of weeks. If the Fed cuts, I would be fairly confident in predicting that the bank is going to cut in October.”
Mr. Amber and Mr. Koeppl are members of the C.D. Howe Institute’s monetary policy council, which makes public recommendations to the bank before rate decisions.
The bank acknowledged on Wednesday – and again Thursday – that the economic damage from the trade war has so far been worse than expected.
Nonetheless, Mr. Schembri pointed out that Canada has been dealing with trade uncertainty for some time, including the prolonged negotiations to update the North American free-trade agreement.
Talk of a U.S. recession – which would drag the Canadian economy down with it – has heated up in recent months as historical indicators of a recession have started to generate concern.