If you are one of those Canadians who binged on credit like it was the second season of Stranger Things, you can relax: the central bank is in no hurry to punish you for your indulgence.
Understand something, though. You owe your extended low-interest-rate holiday to Donald Trump and Kim Jong-un, who teamed up this year to make Earth a less happy place. Their cavalier attitudes towards global norms and world peace have so muddied the near future that the Bank of Canada feels it has little choice but to leave borrowing costs low, even though the country’s economic indicators rarely have been stronger.
“The global outlook remains subject to considerable uncertainty, notably about geopolitical developments and trade policies,” the central bank said Dec. 6 in its last policy statement of 2017.
Bank of Canada Governor Stephen Poloz and his inner circle of advisers on the governing council must attach significant weight to current uncertainty; otherwise, they surely would be raising interest rates. They were notably positive in their descriptions of the things that typically guide central bankers. For example, they said employment growth “has been very strong,” and that wages “have shown some improvement” after a long stretch during which inflation grew faster than average pay increases.
Speaking of inflation, the Bank of Canada also said that prices had “edged up in recent months,” probably because Canada’s economy is growing about as fast as it can before overheating. There’s more: business investment, the absence of which the Bank of Canada was lamenting not so long ago, “continued to contribute to growth after a strong first half, and public infrastructure spending is becoming more evident in the data.” Exports, another long-standing concern, were “exceptionally strong” in the first half, and evidence of a slump this fall is nothing to get overly concerned about, the central bank said. “The latest trade data support the … projection that export growth will resume as foreign demand strengthens,” the statement said.
Oh, and it’s Canada, so we must mention housing. “Housing has continued to moderate, as expected,” the central bank said. In other words, stop all this talk of a bubble bursting. An economy that created roughly 400,000 jobs over the 12 months through November should be able to keep up with its mortgage payments.
The Bank of Canada’s models must be yelling at Poloz to raise interest rates. But the machines aren’t in charge. Human judgment is at least as important, and policymakers have decided that there are too many things that could go wrong in a relative hurry. “While higher interest rates will likely be required over time, governing council will continue to be cautious,” the statement said.
Of all the things Trump has done during his first year in the oval office, reintroducing the threat of nuclear war to the zeitgeist surely is the most surprising. The odds of an actual conflict are low, but not low enough to assume businesses and households around the world will ignore the increasingly menacing taunts of the U.S. and North Korea. “The dictator of North Korea made a choice yesterday that brings the world closer to war,” Nikki Haley, the U.S. ambassador to the United Nations, said Nov. 29 after Kim’s latest ballistic missile test. “And if war comes, make no mistake, the North Korean regime will be utterly destroyed.” Under those circumstances, all central banks will be delaying interest-rate increases if they think they can get away with it.
Still, the bigger source of uncertainty for Canada is the future of the North American Free Trade Agreement. Poloz has been reluctant to predict what the end of NAFTA would mean for the Canadian economy because there are too many variables. However, it’s #MacleansChartWeek, so we have new material at hand that shows why the central bank will be tempted to resist raising interest rates for as long as it can.
Brett House, deputy chief economist at Bank of Nova Scotia, crunched export and import data to show that fewer Canadian and Mexican companies are bothering with the paperwork required to take advantage of NAFTA’s preferences, preferring simply to pay the going U.S. tariff rates, which tend to be low. That suggests Canada’s economy might shake off the loss of NAFTA. But would you risk that assumption if you were running the central bank? Stephen Tapp, deputy chief economist at Export Development Canada, showed in his chart that much of the trade that goes on under the auspices of NAFTA is within companies that have spread out across the continent. Will those businesses be investing if there is a present danger that their business models could be upended at any moment? Probably not, which will tempt the Bank of Canada to offset that likelihood by leaving interest lows.
To be sure, these hypothetical threats will be pushed aside the moment the Bank of Canada thinks it could lose its grip on inflation. The central bank’s effusive description of economic conditions suggests that moment could arrive sooner than some expect. But for now, policymakers have made clear they think there is still room to run. The statement ends with what essentially is Poloz’s dashboard of key variables: “the economy’s sensitivity to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation.”
Let’s go through those in reverse order. Inflation is comfortably below the 2-per-cent target, and wages have only started to show life over the past few months. “Economic capacity” refers to the economy’s ability to generate non-inflationary growth. Poloz’s theory is that Canada’s recent economic strength will inspire entrepreneurs to create new companies and existing ones to expand, improving the economy’s ability to grow without putting upward pressure on prices. There is reason to think there is more to come in this regard. Business investment was extremely weak until recently, and the population of firms is lagging its trend rate of growth.
Poloz’s final variable brings us back to you credit bingers. The Bank of Canada senses that a decade of extremely low interest rates has left households super-sensitive to higher borrowing costs. Household consumption has powered Canada’s economic recovery almost alone, and is now close to the equivalent of 60 per cent of gross domestic product, the most ever. That means that any sign that the two interest-rate increases from the summer are hurting consumption will dissuade the central bank from doing a third.
Bottom line: interest rates are going up in 2018, but probably not by very much.