Bank of Canada Governor Stephen Poloz holds a news conference on the Bank of Canada's decision to reduce the overnight rate, Wednesday, January 21, 2015 in Ottawa. The looming economic threat of sliding oil prices is forcing the Bank of Canada to unexpectedly cut its trend-setting rate to three quarters of a percentage point from one per cent. THE CANADIAN PRESS/Adrian WyldThe Canadian Press
The cut in the Bank of Canada's overnight lending rate to 0.75 per cent seems to have surprised and alarmed many people. Let's look at why it's the right move to make – and some of the implications for Canadians.
As I have argued since 2013 (see this article or this article), that a rate cut is the right course to take. The annual rate of inflation in consumer prices has long been hovering at 1 per cent – the lower boundary of the central bank's inflation target. According to its mandate, the Bank of Canada should have loosened monetary policy some time ago.
But there is more to it than a mandate. An inflation rate of 1 per cent is a sign that the economy is near stall speed. It is at risk of having employment and income growth go into reverse. This is the last thing a country with high debt levels and house prices wants. It could be the catalyst that causes the housing crash many have warned about.
What took the Bank of Canada so long to act? It was the fear of further inflating house prices and debt levels. But this was really a non-issue because policymakers have a separate tool they can use for keeping a lid on debt and house prices: changes to the regulatory framework that governs demand in the housing and mortgage markets.
We have already seen the Department of Finance and other regulators bring in such changes, for example, shortening mortgages to 25-year periods. They can respond with additional tweaks should debt and housing markets remain bubble-like.
Thus, it would be better to get on with the job of reviving the Canadian economy through lower interest rates (which also brings down the Canadian dollar and promotes export growth). The sooner we are assured of the economy's health (while debt and house prices are held in check with the appropriate regulatory settings), the sooner the risk of a housing crash can be dialled down.
But regulatory changes may not be needed to keep debt and housing markets in line. The recent weakness that has emerged in oil and other commodity prices will have a dampening effect on the economy in the quarters ahead. The result could be a moderation in jobs and incomes that keeps debt and housing markets off the boil.
What are some implications of the rate cut for Canadians? It makes mortgages even less costly to carry, so some real-estate investors may be encouraged to gain or increase exposure. The related fall in the Canadian dollar should also eventually support jobs and incomes, and that improves the ability to carry a mortgage. As for investors, stocks linked to Canadian real estate may catch a second wind. Cases in point are Genworth MI Canada Inc. and Home Capital Group Inc.