BoC Governor Poloz says January rate cut was the ‘appropriate amount’

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Bank of Canada Governor Stephen Poloz is signalling that a rate cut may not be in the offing next week as the central bank weighs the state of the fragile Canadian economy.

Mr. Poloz said on Tuesday that the central bank remains comfortable that its one-quarter-percentage-point cut in January was a fitting manoeuvre to buy time for the bank to assess the effects on the country's economy of a dramatic plunge in the price of oil.

"Given what we knew, we think it was the appropriate amount of insurance," Mr. Poloz told reporters after a speech at the University of Western Ontario in London – his final public comments before next Wednesday's scheduled interest-rate announcement.

His comments had investors suddenly betting against a rate cut, sending the loonie up more than half a cent to above 80 cents (U.S.).

Canada and much of the rest of the world are now on divergent tracks from that of the United States, where Federal Reserve Bank chief Janet Yellen is preparing for eventual interest rate hikes as a resurgent U.S. economy picks up steam. Ms. Yellen told the U.S. Senate banking committee on Tuesday that "there has been important progress," even though too many Americans are unemployed, wage growth is still sluggish and inflation is below target.

The U.S. central bank is expected to raise interest rates some time this year, after Ms. Yellen last fall put an end to its stimulus program known as quantitative easing.

Some economists, however, expect that if Canada's central bank does not cut rates in March, it could do so in April.

Mr. Poloz's biggest problem is the negative impact of the swoon in oil prices. He noted that the central bank's assumption when it reduced its key rate to 0.75 per cent from 1 per cent that Brent crude would stay at about $60 a barrel "has held up well so far." Brent closed on Tuesday at $58.66 a barrel.

While Mr. Poloz stopped short of ruling out a further rate cut on March 4 at the bank's next policy meeting, economists said his comments make it much less likely.

"Another curveball from Bank of Canada governor Stephen Poloz has sharply reduced the odds of a rate cut at next week's meeting," Bank of Montreal senior economist Benjamin Reitzes said.

The Bank of Nova Scotia called Mr. Poloz's remarks a clear "shift in communications."

While the negative effects of cheaper oil hit hard and fast – through lower export revenues, layoffs and cancelled investments – Mr. Poloz pointed out that benefits, such as consumer savings, will take longer to materialize and are of "uncertain" magnitude. The bank has estimated that cheaper oil would reduce Canadian gross domestic income by 3 per cent.

"Using the term 'insurance' underscores that we are in a very uncertain setting, and what we are trying to do is to manage the risks we face, not eliminate them," said Mr. Poloz, who did both his Masters and PhD in economics at Western. "We are not in a position to engineer the perfect outcome."

While the bank still believes the negative effects of oil's plunge on Canadian economic growth will outweigh the positive ones, "We took out some insurance until we can figure out just how 'net negative' it is."

Mr. Poloz again dismissed the notion that he favours a lower Canadian currency, and that this was a key objective of the January rate cut. He stressed that the global race to cut rates in recent weeks reflects another round of "serial disappointment" in the world economy, and central banks recognizing the need for monetary stimulus rather than a race to the bottom on exchange rates.

"What does that [weak global economy] mean? It means interest rates have to go down everywhere," he said. "It's not zero-sum. It results in more growth."

Mr. Poloz devoted most of his speech to the notion that the Bank of Canada must move away from basing decisions solely on its 2-per-cent inflation target. He said central bankers need do a better job of making sense of new risks buffeting the financial system, such as exchange-rate moves and globalized production chains.

"We need to develop a monetary policy framework that integrates inflation risks and financial stability risks, both statically and dynamically, and captures much more accurately the uncertainties we face," he said, pointing out that the bank is slated to renew its inflation-targeting agreement with the government next year.

Mr. Poloz said the bank's 2-per-cent target has left it "very little room" to respond to major economic shocks.