Imagine Bank of Canada Governor Stephen Poloz as a physician. His patient, the Canadian economy, is hooked up to a battery of devices, monitoring various determinants of health: inflation, unemployment, economic growth, business investment, oil prices, government spending, exports, the level of the Canadian dollar. The hospital's other patients – the United States, China, Europe – are similarly monitored, because their condition has a big influence on the prognosis for Patient Canada.
Now consider the latest readings on Patient Canada's chart. They're less positive than the last time Doctor Poloz paid a visit, back in April. Some key metrics were expected to improve, but instead moved backwards. The same goes for the health of the other patients; the U.S. didn't have as strong a first half of the year as hoped for, and big question marks hang over China and Europe. That's why Doctor Poloz on Wednesday prescribed an interest rate cut, the second this year.
Low oil prices have sucked both income and investment out of the economy, and to a greater extent than previously anticipated. Global growth faltered in early 2015; as a result, Canadian exports were weaker than expected. It looks like the Canadian economy surprised by contracting during the first half of the year – they call that a recession, folks – and the Bank now expects growth of just over 1 per cent for 2015, roughly half the level it was predicting just a few months ago.
As for inflation – which the Bank uses to take the economy's temperature; too high spells overheating and too low means an economy running cool – the Bank's best reading has it below its 2 per cent target, and unlikely to rise to that level until mid-2017. Ditto for the overall economy.
Lower interest rates do carry a risk, namely that Canadian households will take advantage of them to borrow more, translating into more consumer debt and higher housing prices. But the more immediate worry is that Canadian consumers and businesses will do the opposite: that they will pull back on spending and investment, causing the economy to contract further. All of which could eventually spark a self-reinforcing cycle of economic contraction, housing price adjustment and more contaction. On balance, Doctor Poloz made the right call.