OTTAWA – The Bank of Canada has pointedly dropped its warning about the potential for higher interest rates, triggering a sell-off in Canadian dollars that pushed the loonie almost one cent lower Wednesday and raised speculation that rates could actually fall further.
In a more predictable move, the bank also lowered the anticipated growth path for the economy, shaving the projected pace of expansion for this year as well as in 2014 and 2015.
The central bank, by jettisoning the now familiar tightening bias that it has used since April 2012 to caution consumers about over-borrowing, suggests that it is just as likely to cut the one per cent overnight rate as to raise it in future.
And at a news conference following the release of the bank’s monetary policy report and rate announcement, bank governor Stephen Poloz made no effort to dissuade markets from that assumption.
“The statement is making it clear we have balanced the risks,” Poloz said. “If we were to receive more data flow that was more negative for that inflation outlook, then we would need to rethink that balance.”
However, most analysts doubt the bank will cut the overnight rate below its already historically low setting — where it’s been for more than three years — unless conditions deteriorate materially.
But at the very least, the bank is sending a strong signal that it is prepared to stay low for much longer, likely into 2015.
And the bank is suggesting it is prepared to risk reigniting the housing market and the increased borrowing that might entail if that is what it takes to light a fire under the economy, particularly the critical export sector through dollar-deflating policies.
“The Canadian economy has struggled, struggled with a growth rate that is below two per cent, so I think the bank is prepared to throw down the gauntlet to support growth and exports,” said Bank of Montreal senior economist Michael Gregory.
TD Bank chief economist Craig Alexander says he still believes the governor’s next move is a hike, but says that at the very least he has put some doubt into markets.
“Personally I think the balance of risk is for the next move to be up but I also think the bank was right to drop the forward guidance,” he said, adding that persistent slack in the economy and the low inflation outlook make the threat of higher rates less credible.
The shift in tone is already altering some thinking about the path of interest rates.
The Bank of Montreal sent out a note Wednesday that it has changed its predictions for interest rate increases in both Canada and the United States. It also pushed back its prediction for when the U.S. will start phasing out its quantitative easing program, known as tapering.
That could lead to higher bond yields and the shaving of a few decimal points off five-year mortgages, although the more likely outcome is that the already low interest rate environment that currently exists will stay around longer.
Still, Gregory said the government will need to keep a close eye on the housing market for signs of overheating. If that happens, federal Finance Minister Jim Flaherty may need to tighten mortgage rules once more, he said.
The key explanation given by the central bank for its switch is continued weakness in the country’s export sector, which has restrained business spending on machinery and equipment, and persistent slack in the economy, which has kept inflation below target.
The bank had expected exports to show a bounce in the third quarter, but that did not occur due to the fiscal turbulence in the U.S. and continued weak global demand, it said. Non-commodity exports have been basically flat for some time, noted Tiff Macklem, the bank’s second in command.
What’s more, the bank is not certain why exports have underperformed as much as they have, citing potential competitive pressures.
Poloz said the higher dollar, which remains only a few cents below parity with the U.S. greenback, is a factor but not the main one.
“The main thing is (exporters) lost a lost of sales during the downturn, (when) their biggest market, the U.S., slowed down very dramatically,” he explained. “Many of those companies were forced to become smaller … and there is something like 9,000 fewer exporting firms now than there were prior to the crisis. That’s a lot.”
Poloz and Macklem say they see signs of a recovery, but the so-called “rotation” to export-based growth will take longer than the bank had anticipated.
In essence, the central bank has not changed its view on how and if the Canadian economy will come out of its current slow-growth predicament, but it has pushed back the timing for when it will happen.
The bank now predicts the economy won’t return to full potential until the end of 2015, about six months later than it thought in July.
And the path to there will be slower. Following a disappointing third quarter, this year’s growth will likely only average 1.6 per cent, two-tenths of a point lower than the previous forecast. Next year’s projection has also been lowered by four-tenths to 2.3 and even 2015 will see growth one notch below the July estimate at 2.6 per cent.
“In Canada, uncertain global and domestic economic conditions are delaying the pickup in exports and business investment, leaving the level of economic activity lower than the bank had been expecting,” it said in a summary.