Bank of Canada Governor Stephen Poloz may have solved his communication problem.
It might not seem like it. The central bank’s decision to raise interest rates for a second consecutive time on Sept. 6 qualifies as a surprise, and surprises are what most irritate Poloz’s detractors. The value of the dollar jumped after the announcement, suggesting some traders hadn’t anticipated the move. A group of academic and Bay Street economists that gathers to discuss monetary policy ahead of each Bank of Canada decision had concluded that borrowing costs were fine where they were. And there was all that uncertainty. North Korea’s nuclear ambitions, the renegotiation of the North American Free Trade Agreement, and worries over a U.S. government shutdown this autumn all seemed like good reasons to let things lie.
Another reason to pause: market participants have been struggling for years to understand the central bank’s intentions. They were caught off guard when the Bank of Canada dropped interest rates in 2015. This spring, investors complained about what they saw as an abrupt change in tone at the central bank. Policy makers went from kind of negative on the economy to very positive in the span of a few weeks. The dollar surged then, too, as traders realized that a central bank they had assumed was on autopilot actually was about to change policy. The Bank of Canada did just that on July 12, causing further irritation, including, reportedly, at the Prime Minister’s Office.
The complainers will find it harder to carry on their laments after the latest decision.
Some analysts called it right, and they did so by doing exactly what Poloz has been telling them to do: following the data. On August 31, Statistics Canada reported that gross domestic product grew at an annual rate of 4.5 percent in the second quarter; the central bank in July had predicted only three percent. The difference was too great to ignore. Yet most of us who call ourselves bank watchers shrugged it off anyway, assuming Poloz and his advisers on the Governing Council would lack the guts to raise interest rates two times in a row.
“Recent economic data have been stronger than expected, supporting the bank’s view that growth in Canada is becoming more broadly-based and self-sustaining,” policy makers said in the statement that accompanied their decision Wednesday. “The bank continues to expect a moderation in the pace of economic growth in the second half of 2017, for the reasons described in the July Monetary Policy Report (MPR), but the level of GDP is now higher than the Bank had expected.”
In July, the Bank of Canada said explicitly that future moves would be guided by data. This is what data-dependent policy looks like.
Policy makers increased interest rates by another quarter point because they believe economic output at current levels will put upward pressure on inflation, the one variable they have sworn to control. But their decision also shows the public that they mean it when they say policy will be determined by the most recent information. A pause in the face of a 4.5-percent-annual-growth rate would have signalled the opposite, risking Poloz’s credibility.
It is too soon to conclude that all has been forgiven between Poloz and his detractors. The dollar’s surge to around 82 U.S. seems overdone; still, those who got caught on the wrong side of that trade will be angry about it. People lost money and the central bank will get the blame.
Oddly, the reason Poloz has struggled to forge a healthy relationship with market participants is because of his refusal to tell them what to do. Bankers, investors and traders see themselves as great risk takers, but in reality, most of them run from it. So market participants like it when central banks telegraph their intentions for interest rates in the clearest terms possible. It makes trading so much easier.
From the beginning of his tenure as governor, Poloz has fought this dynamic. Unlike his predecessor, Mark Carney, and the other central bankers who found themselves on the front lines of the fight against the Great Recession, Poloz had time to think about the bigger picture during those events. He observed Masters of the Universe who were putting more effort into assessing the utterances of policy makers than what was actually happening in the economy. That means risk wasn’t being priced properly. When Poloz took over from Carney four years ago, he was determined to end the dependency and force investors to think for themselves.
It’s been difficult. Poloz has had to endure constant sniping over his communications methods on cable television and in the business pages. Some of the abuse was earned; at times, he’s been too stubborn in his assertion that markets should figure out the path for interest rates on their own. But Poloz’s critics are guilty of failing to acknowledge attempts by the Bank of Canada to provide more information. The statements Poloz and his senior deputy, Carolyn Wilkins, read ahead of their quarterly press conferences are rich in context. The central bank now is in the habit of sending out officials to provide updates between its quarterly economic forecasts. Investors have plenty of information with which to work.
And now, the central bank has offered a little more. The most important line in the policy statement comes at the very end. Over the months ahead, “particular focus will be given to the evolution of the economy’s potential, and to labour market conditions,” the central bank said. “Furthermore, given elevated household indebtedness, close attention will be paid to the sensitivity of the economy to higher interest rates.”
This is the Bank of Canada’s way of saying that it probably will be taking a break from raising interest rates for now.
Policy makers are worried about inflation because their best estimates suggest Canada’s economy can only grow at a pace of about 1.4 percent before capacity is used up and price pressures build. But Poloz said in July that there is a decent chance that stronger growth will encourage the sort of investment that would increase the economy’s ability to produce. That would mean a higher non-inflationary speed limit.
Poloz appears now to want to test that theory. There are two reasons to do so. One, some labour-market indicators, including lacklustre wage growth and elevated levels of long-term unemployment, suggest the economy still could benefit from lower interest rates. And two, record levels of household debt demand caution because higher borrowing costs could neuter consumer spending, or even trigger a wave of bankruptcies.
That’s why the dollar’s gains in the immediate aftermath of the interest-rate decision are so suspect. Canadian borrowing costs are headed higher, yes, but only very gradually. Poloz never has been clearer about it.
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