Why a September interest rate hike makes sense - Macleans.ca

Why a September interest rate hike makes sense

If the Bank of Canada’s decisions on rate increases are truly data dependent, Canadians should prepare for another this week


How about another indicator that the era of ultra-low interest rates is nearing an end?

The federal government, which has access to better information than most of us, jumped into the bond market last week with an offer to sell $750 million of debt that will mature in December 2064 – 47 years from now.

If history is any guide, there will be any number of recessions, crises and the like over the decades ahead. That’s why it is normally expensive to borrow money for 50 years. Yet investors were willing to lend Canada hundreds of millions dollars at a ridiculously low rate of 2.2 percent. For an outfit as big as the federal government, which generates annual revenue of $300 billion, and has the sovereign authority to print currency whenever it wants, borrowing at those terms is like getting money for nothing.

Finance’s rush to market suggests its debt managers sensed money only will get more expensive from here. Finance Minister Bill Morneau said in his 2017 budget that he might issue more “ultra-long bonds” on a “tactical basis” this year. The timing was impeccable. The day after the federal government’s bond sale, Statistics Canada reported that gross domestic product surged to an annual rate of 4.5 percent in the second quarter, guaranteeing that the Bank of Canada will raise its benchmark interest rate at least once more before the end of the year.

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There is a realistic chance the next increase could come Sept. 6, which would be sooner than anyone expected only a few weeks ago. When the central bank increased its benchmark interest rate by a quarter point in July, Governor Stephen Poloz said the next change would depend on incoming data. On that basis, the Bank of Canada will need an excellent explanation if it opts against raising interest rates this week. Policy makers had forecast growth of three percent in the second quarter, which means the economy is advancing at a rate that is 50 percent faster than they thought earlier this summer. If the reason to raise interest rates in July was to get ahead of inflation, then the latest data suggest the central bank will have to move faster than it expected.

Some on Bay Street are getting ready for a second consecutive interest-rate increase. Avery Shenfeld, chief economist at CIBC World Markets, had assumed the Bank of Canada would wait until October to raise interest rates again. He advised his clients last week that he now thinks the shift will happen in September. “Nudging interest rates a quarter point higher is clearly warranted after a scorching first half,” Shenfeld said. “We don’t need rates this low to generate decent growth, and can ameliorate future financial system risks by easing household credit demand.”

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Shenfeld is correct in his assessment, but probably wrong with this prediction. At 4.5 percent, the economy was growing a remarkable 3 percentage points faster than the Bank of Canada’s estimate of the non-inflationary growth rate. That means spare capacity is disappearing quickly.

There also is a strong argument for backing up the Bank of Canada’s warnings about household debt with some action. If the central bank is worried about causing a panic, it could make clear in its policy statement that it intends to leave interest rates unchanged for a period of time. Finally, raising interest rates in response to off-the-charts growth data would reinforce Poloz’s message that policy is being guided by the numbers.

Still, the safer bet is the Bank of Canada will find a way to explain why a growth rate of 4.5 percent represents no imminent threat to inflation, even though a slower rate was considered a risk less two months ago. There is a decent argument to be made, although it will require the central bank describing more clearly what it means when it says it is “data dependent.”

The July decision wasn’t especially well understood. They certainly appeared to misread it at the Prime Minister’s Office, as some of Justin Trudeau’s apparatchiks decided to talk to a reporter about their misgivings over how Poloz was running monetary policy. It should have been clear to everyone that the governor was in no great hurry to move borrowing costs higher. Poloz said he thought there was a chance that faster growth would cause companies to hire and invest, thus creating more productive capacity and boosting that non-inflationary speed limit. He said that appears to be what happened in the United States, where the Federal Reserve has been raising interest rates remarkably slowly, even though the unemployment rate is near record lows.

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The Bank of Canada could be inclined to follow the Fed’s playbook. Janet Yellen, the Fed’s chairwoman, resisted early calls to raise interest rates by arguing that there is more to a healthy labour market than a low unemployment rate. She said elevated numbers of underemployed Americans and stagnant wage growth justified low interest rates for a longer period of time. The Bank of Canada made the same point in July. In its latest quarterly report on the economy, the central bank noted that “elevated levels of long-term unemployment and below-trend average hours worked” implied that there still was slack in the economy. If it leaves interest rates unchanged this week, that will be an important part of the justification.

But make no mistake, a decision to pause in September will be delaying the inevitable. One difference between the Fed’s experience and what the Bank of Canada is assessing now is that the U.S. economy never took off in the way that Canada’s has over the past year. A data-dependent central bank can only ignore the data for so long.


Why a September interest rate hike makes sense

  1. Good……shoulda been done long time ago.

    • Emilyone Makes sense only to you and the incompetent liberal government, 50 billion in debt borrowing 150 million, I’ll bet you still cheer for justin.

  2. The campfire was burning slowly but steadily under Harper. The Bank of Canada could keep its fire extinguisher in the trunk of the camper. Trudeau and Morneau poured gasoline on the campfire (with massive deficits) which is now forcing the Bank of Canada to take its fire extinguisher (higher interest rates) out of the trunk, and start using it, leaving the economy no further ahead, and arguably in a worse place than it was before the gasoline was poured on the fire by Trudeau and Morneau.

    • WHYSHOULDISELLYOURWHEAT right on, we would have better governance with grade school kids.

    • If you are going to play this game you need to learn your lines. No real conservative thinks government spending causes inflation. You don’t get inflation from fiscal policy it comes from monetary policy. Conservatives think this government spending is having no impact at all except to reduce private investment and eventually increased taxes. Inflation and overheating does not get into it – you are sounding like a Leftie when you say that stuff.
      Umm, as for grade school kids, there were only a few Nobel prize winning economists advising the government to run deficits. No doubt you fellows know way more about it than those guys.

      • Canada is really a bit player in all of this.

        The Fed, the ECB, and the BOJ have being conjuring out of nothing trillions of dollars, euros, and yen, along with other insane polices like NIRP and ZIRP. This has depressed economic growth around the world, and massively inflated bubbles in essentially every asset class (except gold).

        The oil crash was directly caused by all this Ponzi money which fueled the non-economic shale oil boom in the United States, which cause the oil shock in Canada, which force the BOC to lower interest rates from 1% to 0.5%.

        Deficit spending in Canada is not creating sustainable economic growth in Canada, but it is forcing the BOC to normalize interest rates prematurely.

        The patient was weak but stable with the oil price shock in Canada. Trudeau and Morneau pumped up the patient with amphetamines, and now the BOC is being force to act because of all this phony economic growth, but the higher interest rates will likely have side effects on government and individual and corporate balance sheets that will leave the patient in worse shape than if Trudeau and Morneau had left well enough alone. The vital signs may be slightly higher, but the patient is in a much more precarious and less stable state, and more fragile when the next shock hits.

        • Yes, well. You are totally free to think all that stuff, of course. And economics being the inexact science it is, who knows, perhaps you will be collecting a Nobel Prize in a few years. I can only say with a fair degree of confidence that for right now, there isn’t any evidence to support what you are saying. Shale oil is economic at $40/barrel. It’s rise has nothing to do with low interest rates. Check out RBN Energy.
          I think you might be a bit confused about interest rates. You are saying our government is raising interest rates prematurely and at the same time you are complaining because interest rates around the world are insanely low.
          And you say that low interest rates cut off growth. Economists are more puzzled about why the recovery from the last recession has been so slow and they think low interest rates is a way to avoid deflation and encourage growth.