Well, anyway, that’s one narrative coming out of the Bank of Canada policy announcement this week, which was, really, a bank policy announcement that didn’t have much in the way of narrative to offer. It certainly wasn’t a surprise. Inflation in July had come in higher than expected, at two per cent — right on the Bank’s target. As well, second-quarter GDP data showed a big growth surprise to the upside, at 3.7 per cent. So on one hand, there was little pressure for the Bank to cut. But on the other hand, a lot of that growth surprise came from one-offs, like the surge in Q2 exports that mostly just showed how dismal exports were in Q1. And looking forward, there are plenty of storm clouds gathering on the horizon — the impact of trade wars, a slowdown in global growth, and so on. Given that, there was certainly no one expecting the Bank to hike.
And it didn’t.
Now the question turns to when the Bank will cut — maybe October, maybe later this year, maybe early next. The widespread expectation in the markets is that it will have to fall in line with the global trend and start to ease, as the adverse impacts of the U.S.-China trade war, the Brexit mess and various other growth-inhibiting skirmishes start to show up in the data. Lower rates are coming (probably). Good news for the economy, right?
Well, are you feeling excited about the prospect of more monetary stimulus? Is anybody?
I guess you could point out that at least the Bank of Canada has kept more of its interest-rate powder dry than other central banks have. Canada now stands as one of only a handful of developed economies with a policy rate above zero; Norway (1.25 per cent), Australia and New Zealand (both at one per cent), the U.K. (0.75 per cent) and Israel (0.25 per cent) are among the others. Leaving aside Iceland (4.25 per cent — and no, I’m not sure why), the U.S. has the highest policy rate among developed economies, at 2.25 per cent. (That’s widely expected to come down by a quarter point later this month.)
And that’s about it. Famously, the eurozone has been at zero for years (though its non-headline rates are negative). Japan has been at -0.1 per cent since 2016. Sweden went negative (to -0.25 per cent) last December. Denmark’s policy rate is -0.65 per cent. Switzerland, the pioneer of negative rates, is -0.75 per cent.
So Canada has the second highest policy rate among developed economies (again, excepting Iceland). You could argue that this gives Canada more room to manoeuvre in the event of another big downturn, which is true in absolute terms. But let’s not make that a point of national pride just yet.
While it’s true that Canada’s policy rate is high by developed-country standards these days, and higher than it was a couple years ago, we shouldn’t forget the fact that 1.75 is still a really, really low rate, especially for a non-recessionary period in absolute terms.
It’s also lower than inflation, which is running at two per cent, which means the real interest rate (the interest paid on short-term securities minus the rate of inflation) in Canada is still less than zero, as it has been since the last recession. That continues to make borrowing relatively cheap — 1.75 isn’t going to prick Canada’s household debt bubble, no matter how it compares with rates in Brussels. And it’s making saving relatively expensive: savers can pretty much expect to lose purchasing power to inflation every year if they hold on to low- or no-risk securities, and that’s with inflation running at or below two per cent. It’s also a huge challenge for pension funds, whose liabilities go up when rates go down; if negative real rates continue, folks enrolled in defined benefit plans should expect higher contribution levels, lowered benefits, or both.
The other thing is that while 1.75 might give the Bank of Canada more powder than other central banks, it’s an open question whether it would be enough if a deep recession hits. During the last recession, the Bank lowered its target rate by more than four percentage points. If a similar downturn hits, that would imply a target rate below negative two per cent — which would be brand new territory by any standard. Even in the event of a milder shock, 175 basis points is a slim margin to stimulate an economy, at least by historical standards.
The point is, Canada’s relatively higher rates now don’t necessarily provide a buttress against recession or even leave much room for further stimulus to ward it off. Holding steady against what looks like a global trend does not change the way of the world.
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