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Bank of Canada’s rate policies in ‘uncharted waters’

Stephen Poloz is expected to leave the key interest rate at 1 per cent this Wednessday.

Andrew Harrer/Bloomberg

When Stephen Poloz leaves the Bank of Canada's key interest rate at 1 per cent on Wednesday it will be the 29th consecutive meeting that the central bank does nothing.

If economists are right, the bank won't start raising rates again until the middle of next year. That would mark nearly five years at 1 per cent – the longest span of monetary inaction in more than six decades.

So when should Canadians expect a return to more normal interest rates? Maybe never, Bank of Montreal chief economist Douglas Porter says.

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"Even when rates do finally begin to rise and move back toward 'normal,' we are likely to find that normal is lower than it was prior to the financial crisis," he argued in a recent research note.

Before the financial crisis, the assumption in Canada was that an overnight rate of 4 per cent or 4.5 per cent was considered neutral – not so low that it spurs inflation, nor too high to stifle economic growth. Mr. Porter said the central bank's neutral gear could now be a full percentage-point lower, perhaps just 3.5 per cent.

The bank influences interest rates by adjusting its target for the overnight rate – the interest that major financial institutions charge each other for short-term funds.

Nothing, it seems, is normal after the financial crisis. The global economy appears to be entering a period of much slower growth, with higher rates of saving and an aging population. And that could mean low interest rates for longer, followed by a gradual return to normalcy.

Some analysts also predict that when Bank of Canada does move, it will move more cautiously than the U.S. Federal Reserve.

In a recent report, Bank of Nova Scotia economists Derek Holt and Dov Zigler argue there is a "serious risk of an unprecedented lag" between the Bank of Canada and the Fed. These are "uncharted waters," they said.

If the Fed makes its first rate hike in the second quarter next year, Mr. Poloz and the Bank of Canada might not move until the fourth quarter, according to Scotiabank.

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Among other factors, Mr. Holt and Mr. Zigler said slower growth and weaker inflation in Canada will cause the Bank of Canada to hold off.

Among the potential consequences – downward pressure on the Canadian dollar.

Also Wednesday, the central bank is due to release its latest forecast – the first update since January. Economists are betting that Mr. Poloz might be forced to, again, lower his expectations for growth in Canada, while acknowledging that inflation is starting to perk up a bit.

The bank had been calling for the economy to grow at an annual pace of 2.5 per cent for the quarter.

That isn't like to happen, and a downgrade to about 1.5 per cent looks possible.

The bank's full-year forecast is for growth to 2.5 per cent. And that too may be at risk, says Bank of America Merrill Lynch economist Emanuella Enenajor. She's looking for the bank to "maintain a cautious tone on growth, careful not to say anything to trigger Canadian dollar strengthening."

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After hitting a 4 1/2 year low in March of below 89 cents (U.S.), the Canadian dollar has edged back up again to more than 91 cents. Analysts say the Bank of Canada would be happy to see the Canadian dollar weaken, which would help boost the country's export sector.

In addition to releasing its quarterly monetary report, Mr. Poloz will also take questions from reporters, alongside the bank's senior deputy governor, Tiff Macklem. It could be Mr. Macklem's final public appearance before he leaves in June to lead the University of Toronto's Rotman School of Management.

On Friday, the central bank named Carolyn Wilkins, an economist with the bank, as Mr. Macklem's replacement.

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