In a Bank of Canada interest-rate announcement that runs 385 words, that word – in the final sentence of the statement – was the only one that really mattered to financial markets. To traders parsing the central bank's latest communication, it not only justified the bank's decision to hold its key rate steady at 1 per cent (which was universally expected), but signalled that the bank is also unlikely to raise rates at the next decision date, in mid-January.
It was the second time the Bank of Canada used "cautious" to characterize its approach to future rate increases, after having raised rates twice in the summer. But it seems that the word is already considered, by traders, at least, to be the bank's shorthand for "no rates ahead until we stop saying this word."
The evidence of that conviction was all over the markets on Wednesday. The bond market immediately reduced its pricing of the probability of a January hike to 25 per cent, from about 40 per cent the day before the announcement. The Canadian dollar duly tanked on the diminished interest-rate expectations; by late afternoon, it had lost eight-tenths of a cent against its U.S. counterpart.
Thing is, if you had read everything in the rate statement up to the appearance of "cautious," you might have thought the Bank of Canada was ready to take a step toward another rate hike, not a step back. On most fronts, the central bank sounded more encouraged by economic developments. Global growth continues apace and the U.S. economy has been stronger than expected. Business investment and government infrastructure spending are both giving the Canadian economy a lift. Slack in the labour market is "diminishing." Inflation has been rising – indeed, faster than previously anticipated, although temporary factors are contributing. (When do they not?) The bank even squeezed in a sentence about the latest monthly trade data – released just the day before, pretty much at the wire for inclusion in the rate announcement – to say the numbers support expectations that export growth would bounce back from a tepid third quarter.
Yet "cautious" trumped all that.
Usually, that's the sort of thing that would annoy the Bank of Canada. Its communications staff have been frustrated before by markets latching onto a single word or phrase, rather than reading the entirety of its message and thus misreading the bank's intent.
But in this case, the bank has made it pretty clear that caution is quite central to its current thinking. If anyone hadn't grasped the significance to the word when the bank introduced it to its rate statement in October, the bank's second-in-command, Senior Deputy Governor Carolyn Wilkins, dedicated a substantial chunk of a speech last month to the need for a cautious approach to setting monetary policy amid uncertainty. Once you give a speech like that, you have to expect that observers will be watching that particular element of your communications especially closely – which, one has to conclude, was the bank's intent.
And there are a few uncertainties that are approaching crunch time for Canada's central bankers. They're not entirely sure how the two rate hikes of earlier this year will affect economic growth, as the elevated levels of Canadian household debt may mean that higher rates will deliver a bigger-than-usual blow to consumer spending. They're not sure how much slack remains in the labour market and to what degree it will trigger wage inflation, which has been very slow to take hold in this economic recovery. They're not entirely confident how close the economy is to full capacity – the critical gauge for assessing how urgently rate increases are needed to keep the economy from overheating.
The granddaddy of all uncertainties is the threat of a NAFTA collapse. The Bank of Canada didn't mention NAFTA by name in its rate announcement, but there's no doubt that it casts a shadow over its outlook for rate policy. If the central bank were to get more aggressive in raising rates in the next few months and then the NAFTA talks were to fall apart, it would almost certainly constitute an economic shock warranting a reversal of those hikes – much the way the Bank of England cut rates in a rapid response to the Brexit vote. But Ms. Wilkins made clear in her speech that the bank has a distaste for reversing a rate-hiking cycle once one has started.
Still, the markets need to use some caution in putting too much weight into what they believe the Bank of Canada is signalling. This is a central bank that, in the past three years, has surprised markets not once but twice with rate moves that were not foreshadowed in the bank's communications. Governor Stephen Poloz has shown a willingness to act without sending advance signals, and has rarely allowed his policy to be defined narrowly by a specific word or phrase, or the absence thereof.
Mr. Poloz has spent much of his tenure in the governor's office advising the markets to watch the economic data and think for themselves. The next rate hike will come when the economic indicators have persuaded the Bank of Canada that it's time – regardless of which word it uses to describe how it approached that decision.