A primer on interest rates, plus! — a poll
Newly minted Bank of Canada Governor Stephen Poloz will be answering questions from MPs Thursday in his first testimony before the Standing Committee on Finance. There have been a few photo-ops, but so far we haven’t heard much from our new central banker. This is Poloz’s first chance to give us a hint of what he has in mind for Canada’s monetary policy. The question that’s on everyone’s mind, of course, is: Which way will interest rates go? The next interest rate announcement until July 17 but everyone will be looking for hints tomorrow that indicate which way the BoC’s new boss is leaning.
The Bank of Canada sets the so-called policy rate, which is the average rate the BoC wants to see banks using when they lend money to each other overnight. The key policy rates influences commercial interest rate, such as those charged by mortgages providers, and has been set at one per cent since September 2010. Anyone who remembers where interest rate were in the 1980s—which wouldn’t be this correspondent—knows how incredibly low one per cent is (in 1981 the BoC was at one point charging over 20 per cent interest on loans to other financial institutions). But interest rates throughout the developed world are at rock bottom right now. Central bankers slashed them during financial crisis to encourage borrowing and investment—and, in the U.S., likely also to limit homeowners’ defaults. The fact that they’re still so low is a testament to how slow the global recovery has been.
Interest rates, though, aren’t just the cost of borrowing: They’re also the reward that savers get for lending their money (a reward has been dreadfully small for quite a while now). Generally, raising interest rates attracts capital because some investors will move some of their money to where they can get better returns. Higher interest rates in Canada means that there will be more demand for the Canadian-dollar assets, which increases the price of the loonie relative to other currencies. An appreciation of the Canadian dollar, in turn, makes Canadian exports less competitive.
Now, an actual interest rate raise would be quite a bold move considering that the global economy is still sputtering, meaning that demand for Canada’s exports is rather weak. On other other hand, lowering the policy rate could be equally risky, as it might further encourage borrowing at a time when Canadian household owe $1.65 for every dollar of disposable income and housing prices are at record highs.
Poloz’s predecessor, Mark Carney, kept the policy rate unchanged for almost three years but had long been promising that the Bank would eventually raise rates, something economists call “a tightening bias.” Poloz’s choice, then, many economists suggest, is really between maintaining Carney’s tightening bias and eventually hiking up rates in late 2014 or early 2015, or removing that bias and keeping rates where they are for the foreseeable future.
What would you do? Take a our survey at the bottom of this page! To help you make up your mind, below is a list of recent economic data and studies that could be as reasons to maintain the bias or to drop it. (They’re by no means exhaustive lists.)
Reasons for keeping the tightening bias:
Reasons for dropping the tightening bias:
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