In recent years, as the world's leading central banks have moved toward more transparency in their policy thinking, the element of surprise has become a relic of bygone years, locked away and collecting dust in the attic. The Bank of Canada just dusted it off and proved it can still make one hell of a bang.
The Bank of Canada's decision Wednesday to cut its key interest rate by one-quarter of a percentage point, to 0.75 per cent, was a flat-out shocker. Sure, some economists had mused that the central bank should be considering a rate cut, as the free fall in oil prices threatened to slam the brakes on Canada's economic growth, constrain national income, slow business investment and sap hiring.
But this isn't the way modern central bankers do this kind of thing. They are supposed to send signals, by first changing their rhetoric in speeches and (especially) in rate policy statements to reveal that they are about to change direction, before actually moving in that direction. It's all about broadcasting and baby steps.
Secrecy and big surprises have been supplanted in global monetary policy in recent years by "guidance" – central banks giving increasingly explicit detail about their policy direction, intentions and timing. In the turnaround from the depths of the financial crisis, this kind of clarity was lauded as pivotal to providing the certainty and confidence the world needed to get its financial and economic wheels turning again.
But several central banks seem to have concluded that the time for guiding is over; the time for using brute force has arrived. In the past week, Switzerland, Denmark, India and now Canada unleashed surprise policy cuts. Toward the end of last year, China, Japan and Norway unveiled similar policy stunners.
It should be said that the Bank of Canada had already made clear that it wasn't enamoured with the transparency being practised by many of its international peers. Governor Stephen Poloz has dismissed suggestions that the bank should publish minutes of its Governing Council policy meetings, as the U.S. Federal Reserve Board does with the deliberations of its Federal Open Market Committee.
Last fall, he said he wasn't interested in providing forward guidance, either – the bank's policy statements would no longer spell out its "bias" (whether it leaned toward raising, lowering or keeping rates steady in the future), but rather would lay out the facts and risks and let market participants figure it out for themselves.
In retrospect, it's hard to avoid thinking that Mr. Poloz wanted to hold back his cards precisely for a moment such as this. He wanted to be sure he had the capacity to shock the markets, if and when he needed it. Shock may not have been the overriding purpose of this rate surprise, but it would be naive to think it wasn't a big attraction to the plan.
Mr. Poloz certainly could have steered market thinking in a new direction simply by indicating in Wednesday's policy statement that he was pondering a rate cut, thus telegraphing a cut that he could have made at the bank's next meeting in early March. But if monetary policy is going to be used to mitigate the impact of a sudden and intense economic shock – and that's what oil's decline has been for Canada – then time is of the essence.
The most visible, and predictable, consequence of the surprise cut was the immediate selloff of the Canadian dollar. I've never believed much in the theory that Mr. Poloz, formerly the head of Canada's export development agency, habitually uses the Bank of Canada's policy stance to drive the dollar downward to lend a hand to the export sector. But in this instance, a currency downturn does cushion the effects of the oil shock, giving oil producers some foreign-exchange relief and providing an offsetting lift to non-energy exporters. It even helps prop up flagging inflation – another key concern for the central bank.
And given the widening rate-cut mania (and with the European Central Bank poised to ease its monetary policy Thursday), there was a growing risk that the Canadian dollar might actually face upward pressure in the midst of this oil shock as currency speculators go shopping for markets where rates aren't falling. That would have sent the Canadian economy out of the frying pan and into the fire. The Bank of Canada's surprise cut has instantly taken the loonie off the potential "buy" list and planted it firmly in the "sell" column – which, whether Mr. Poloz is willing to say it out loud or not (and he's not), is a convenient place for it to be right now.
Still, the surprise cut will leave Mr. Poloz and his colleagues with a credibility issue. The whole point of transparency is to lessen the guesswork that can fuel market volatility and shake confidence. When you yank away that predictability, you might get the desired effect for now, but that genie will be hard to get back in the bottle.
Consider what transpired after the rate announcement. Mr. Poloz was telling a press conference that the oil shock was merely a "setback" for Canada's recovery, and calling the rate cut a bit of "insurance" to keep things on track. The bond market? It was busy pricing in the possibility of another rate cut, in March.