The Bank of Canada has laid out a clearer path for interest rates, pushing back the timing of an eventual increase, while warning for the first time that it could boost rates to dissuade consumers from taking on more debt.
Hardening its resolve that the days of ultra-cheap money must come to an end, the central bank Tuesday stopped describing higher borrowing costs as a possibility, stating unequivocally that "over time, some modest withdrawal of monetary policy stimulus will likely be required."
Policy makers also for the first time tied their rate stance to the evolution of household debt, singling out "imbalances in the household sector" as a factor that could force an increase of the Bank of Canada's benchmark rate from its current setting of 1 per cent.
Canadian household debt was 167 per cent of income in the second quarter, a level that the central bank considers a threat to financial stability because a wave of personal bankruptcies and home foreclosures could cripple the banking system.
Bank of Canada Governor Mark Carney has been warning Canadians to go easy on credit for the better part of two years. It was a mixed message, to be sure, necessitated by the need to keep interest rates low to help the economy advance against headwinds such as a strong currency and a tepid U.S. recovery. Still, by applying moral suasion, Mr. Carney was attempting to keep a credit bubble from inflating to dangerous proportions.
Yet with the passage of time, it is possible Mr. Carney's lectures were starting to lose their power. The central bank left its benchmark overnight target unchanged for a 25th consecutive month Tuesday, a pause unseen since the early 1950s. By codifying an explicit commitment to raise interest rates in the policy statement, policy makers are reinforcing their role as guardians of financial stability, and not simply stewards of non-inflationary economic growth.
"Households need to slow their borrowing on their own, or else the Bank of Canada will give them reason to do so," Avery Shenfeld, chief economist at CIBC World Markets in Toronto, said in a report on the Bank of Canada's new stance.
But even while hardening its commitment to raise interest rates eventually, the central bank softened on the timing, acknowledging that the Canadian economy has had a tougher go of it this year than policy makers had expected.
Canada's gross domestic product grew at annual rates of 1.8 and 1.9 per cent in the first and second quarters, respectively. That stretch of "below potential growth" means Canada is further away from reaching the level of economic output that the central bank considers to be inflationary. The Bank of Canada now says the economy will reach "full capacity" at the end of 2013, a shift from its previous estimate that potential growth would be reached in the "second half" of next year.
Since April, the Bank of Canada had been talking about a potential rate increase in the context of an "economic expansion" that failed to achieve the velocity that policy makers expected, keeping a lid on inflation, which the central bank is mandated to contain at an annual rate of about 2 per cent. By acknowledging that the economy is struggling, policy makers also sent a message that there is little reason to expect higher interest rates any time soon.
"The bank wants to make absolutely clear that it is not contemplating rate cuts at this time," said Jimmy Jean, an economic strategist at Desjardins Securities Inc. in Montreal.
The Bank of Canada today actually raised its forecast for economic growth this year to 2.2 per cent from 2.1 per cent in July, reflecting revisions of government data. The central bank foresees growth of 2.3 per cent in 2013, unchanged from its last outlook, and 2.4 per cent in 2014, down from 2.5 per cent previously.
Policy makers described this growth path as a "moderate expansion." Canada's economy is being held back by a lack of demand for exports, the result of a recession in Europe and slower-than-expected growth in China and other big emerging markets. Exports won't reach their pre-recession peak until the first half of 2014, the Bank of Canada said.
That means the strength of Canada's economy largely will be determined by the amount of consumer spending and business investment. And the central bank would like consumers to spend a little less, if it means taking out more home loans and stretching their lines of credit. The Bank of Canada predicted that household debt likely will rise a bit more before "stabilizing" over the course of the next couple of years. If household debt doesn't follow that path, expect policy makers to try to do something about it.