As it prepares for Wednesday's interest-rate statement, the Bank of Canada finds itself walking a policy tightrope: How to address the country's sluggish economy and perilously low inflation pace, without pouring gasoline on the housing and household debt fires in the process? A growing number of pundits think they have the answer: Start talking about interest-rate cuts.
Just talk about them, mind you.
By shifting to an "easing bias" – i.e. suggesting that the central bank's next rate move could be a cut – the bank would lower expectations about the future rate trajectory in Canada, which would discourage the buying of Canadian dollars in the highly rate-sensitive currency markets. If a lower dollar could be achieved without actually cutting rates, the bank would avoid making borrowing even cheaper for consumers, something it is loath to do as it seeks to cool an overheated housing market and stubbornly high consumer debt.
This was the recommendation last week from the C.D. Howe Institute's Monetary Policy Council, a group of 12 of the country's leading academic and private-sector economists. The council proposes that Wednesday's rate-setting announcement include language to the effect that the bank is prepared to cut rates if the output gap doesn't close as expected, and/or inflation persists well below the bank's 2-per-cent target.
The stimulative benefits of a weaker dollar are two-pronged. It accelerates Canada's export activity (a key element in Bank of Canada Governor Stephen Poloz's recovery game plan) by making Canadian exports cheaper for foreign buyers. And, critically for a central bank whose monetary policy is anchored to inflation, it puts upward pressure on prices by making imports more expensive for Canadian consumers.
The old rule of thumb is that a three-cent (U.S.) move in the loonie has an economic effect roughly equivalent to a one-percentage-point change in the Bank of Canada's policy rate. When you have little room to lower rates to provide economic stimulus, talking the currency down can be a powerful tool.
It's a good idea. So good, in fact, that the bank has already done it. To do more at this stage looks unnecessary, maybe even risky.
The central bank's decision in October to shift from a tightening bias to a neutral stance (it dropped wording from its rate-policy statement suggesting that rates would eventually move higher) had an immediate effect: The dollar is down more than 3 cents against its U.S. counterpart since the announcement. Assuming the repricing of the currency sticks, the bank may have effectively pulled off a significant easing by deleting a sentence.
A further downshift, to an easing bias, would certainly trigger further dollar declines – which would be wholly appropriate, given the erosion in Canada's terms of trade. But by the same token, the policy shift wouldn't be neutral to housing and consumer debt. It would move the central bank a step further from rate increases, giving consumers a bigger cushion to enjoy extended low rates and thus encouraging borrowing, including mortgages.
Meanwhile, it's unclear whether there's any urgency to ratchet up the dovish language. Recent economic data, most notably the third-quarter GDP report, suggest the Canadian economy may have gained traction. And the dollar is still retreating without the Bank of Canada upping the ante, thanks to both October's shift in bias and a substantial weakening in commodity prices.
Remember that the central bank is also, traditionally, not fond of changing policy direction at its last meeting before the holidays. With both the dollar and the economic indicators taking pressure off, the bank has ample reason to let its neutral stance play out for a while longer.