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Poloz unlikely to cut rates, despite deflation concern

Stephen Poloz's biggest headache these days is disinflation.

But don't expect the Bank of Canada governor to actually do anything about it – at least not right now.

On Wednesday, the central bank makes the first of eight scheduled rate-setting announcements of 2014. The bank will also update its closely followed economic forecasts. And Mr. Poloz will take questions from reporters in his first news conference of the New Year.

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An interest rate cut would arguably be the tonic for chronically weak inflation – now running at an annual rate of less than 1 per cent, or ominously below the central bank's 2 per cent target.

But there isn't an economist of note in Canada ready to predict that's what Mr. Poloz will do.

"The biggest taboo subject among economists in Canada is whether policy is too tight," said Ian Pollick, fixed-income strategist at RBC Dominion Securities in Toronto. "I believe it is. But it's not necessarily the case that we need to see a response, given today's data."

The Bank of Canada moved to a neutral monetary stance in October, implying an equal likelihood that its next move will be a rate cut, or a hike. The bank's key overnight lending rate has been fixed at 1 per cent since September, 2010. "Poloz has really defined himself by making it clear there is symmetry behind the bank's inflation mandate, namely that 'if it goes too far on either side, we have to respond.' "

And yet not one of 37 economists polled by Reuters last week expects Mr. Poloz to act Wednesday. Indeed, all of the respondents say the bank's next move will be to raise rates. The median forecast is a quarter-percentage-point increase in mid-2015, according to the poll.

So while Mr. Poloz has struck a distinctly more "dovish" tone on rates than his predecessor Mark Carney, economic conditions make monetary easing tricky and potentially dangerous.

The U.S. Federal Reserve has begun the process of removing monetary stimulus – so-called tapering – as the U.S. economic recovery gathers momentum. That is already putting upward pressure on longer-term interest rates in Canada. So Mr. Poloz can't get too far out of step with where the Fed and the U.S. economy are heading.

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Mr. Poloz also doesn't want to do anything to unsettle the soft landing he wants to see in the housing market, or the gradual unwinding of Canadians' record-high household debt loads. Lower rates would spur more borrowing.

And finally, signalling that a rate cut is imminent might halt the welcome slide in the Canadian dollar, which has already lost nearly 3 cents (U.S.) this year.

"The last thing he wants to do is sound more hawkish and burst the slide we've seen in the loonie," Bank of Montreal senior economist Benjamin Reitzes said. "So he's going to do his best to balance that."

On balance, a dollar near 90 cents (U.S.) is likely good for the Canadian economy. It gives a cash boost to exporters and manufacturers, while importing a refreshing bit of inflation via higher prices on foreign-made goods.

The central bank is anxious to see lagging exports pick up again, shifting the economy's main driver away from consumers and housing.

Mr. Poloz addressed his rate-cut conundrum in a recent interview with CBC television, pointing out that "minimizing the risks of making a big mistake is what we're trying to do and that tells us we should be holding rates where they are until the data flow changes our mind."

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With a rate cut and a change in the Bank of Canada's monetary bias likely off the table this week, economists are nonetheless expecting Mr. Poloz to continue to highlight the threat of disinflation.

"Rate cuts are not very appealing," BMO's Mr. Reitzes said. "So they are stuck. There is not a whole lot they can do."

The bank may also have to downgrade its inflation projections, contained in the bank's monetary policy report.

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About the Author
National Business Correspondent

Barrie McKenna is correspondent and columnist in The Globe and Mail's Ottawa bureau. From 1997 until 2010, he covered Washington from The Globe's bureau in the U.S. capital. During his U.S. posting, he traveled widely, filing stories from more than 30 states. Mr. McKenna has also been a frequent visitor to Japan and South Korea on reporting assignments. More

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