Expect Bank of Canada to maintain interest rates in September, unless GDP is off the charts

  8/27/2018 |   SHARE
Posted in Mortgage Interest Rates by Eileen Farrow | Back to Main Blog Page

Stephen Poloz Bank of Canada

Bank of Canada Governor Stephen Poloz has put an early stop to the debate over whether he might be persuaded to raise interest rates in a couple of weeks.

Poloz used public remarks at the Federal Reserve Bank of Kansas City’s annual central banking retreat in Jackson Hole, Wyoming to emphasize that he remains unworried about inflation, even though the consumer price index jumped to the outer limit of the Bank of Canada’s comfort zone in July.

Canadian policy makers had expected that inflation “would head up towards three per cent,” the annual increase Statistics Canada recorded last month, Poloz said in an interview with CNBC on Aug. 24.

“These are transitory factors,” the governor said.

Many economists predicted Poloz would say something like that as soon as he had an opportunity to comment on the latest price data.

Still, there was room to wonder. If Canadian policy makers thought the CPI could brush three per cent, they were keeping it to themselves. The Bank of Canada’s latest economic outlook predicts inflation of only 2.5 per cent in the third and fourth quarters before cooling early next year.

The Bank of Canada raises and lowers interest rates to keep the CPI advancing at an annual rate of about two per cent. But central banking isn’t like darts, so policy makers give themselves room to maneuver; they are generally comfortable if inflation stays above one per cent and below three per cent.

The three measures of “core” inflation that the Bank of Canada follows to get a truer read of price pressures all are around two per cent. That’s evidence the headline number is being pushed higher by volatile components of the consumer price basket and some one-off factors, such as changes in the exchange rate and higher fuel prices.

“Our measures of core inflation, which extract all the noise from the data, are all right around two per cent — so, very close to target,” Poloz said on CNBC.

Poloz may need to repeat that message to make sure it sticks with the public.

Concern about inflation can be self-fulfilling: If executives and workers begin to think the cost of living and doing business is about to jump, they will demand more compensation in return for their services. Inflation at three per cent could alarm some people because prices tend not to rise that fast anymore: the headline CPI number last touched three per cent in 2011.

Poloz’s comments at the end of last week will be the last from a Bank of Canada official before the central bank announces its next interest-rate decision on Sept. 5. Most think policy makers will opt to leave borrowing costs unchanged, but a steady stream of better-than-expected indicators has made the consensus wobbly. Economists at Bank of Nova Scotia have been making a spirited case for an increase next month, arguing that a benchmark rate of 1.5 per cent is too low for an economy that’s probably growing at an annual rate of around three per cent.

Derek Holt, an economist at Scotia, didn’t see a signal in Poloz’s comments on CNBC. “It was a blended message that did not provide concrete direction or guidance on timing the next hike in a hiking cycle which is not unexpected given his tendency to avoid explicit guidance,” Holt said in a note to his clients after Poloz’s remarks.

Policy makers won’t start thinking hard about their next move until they receive an assessment of the economy and a policy recommendation from Bank of Canada staff in the days ahead.

StatCan will also release its survey of second-quarter gross domestic product on Aug. 30. A positive surprise could spur the central bank to raise the benchmark rate for a second time in a row. Real-time forecasts predict a second-quarter growth rate of about three per cent, faster than the Bank of Canada’s July outlook of 2.8 per cent.

While it’s true that there was no concrete guidance from Poloz in Jackson Hole, most investors will read his blasé response to the latest inflation data as an indication that the central bank will stay true to its promise to lift interest rates only gradually. The Bank of Canada raised the benchmark at its last meeting in July, so it would have some explaining to do if it opted to do so again at its next opportunity.

To be sure, Poloz and the Governing Council increased interest rates at back-to-back meetings a year ago, but only after second-quarter GDP surged to 4.5 per cent, more than a percentage point faster than the central bank had predicted. Policy makers also were eager to unwind the emergency monetary stimulus they had deployed to counter the collapse of oil prices in 2015. They are more comfortable with the level of interest rates today.

Poloz also participated in a panel discussion in Jackson Hole on Aug. 25. His remarks suggest that he feels he has inflation cornered.

The governor talked about how digitalization is changing the economy, and reminded his audience that statisticians are struggling to measure contributions from things such e-commerce and cloud computing. He noted that potential growth rates keep getting revised higher and wondered if that’s why inflation has stayed so low in recent years.

Potential growth refers to the pace at which an economy can grow without triggering inflation. If there’s reason to doubt the accuracy of current estimates of potential, central bankers have cause to proceed cautiously.

“Taking a gradual, data-dependent approach to policy is an obvious form of risk management in the face of augmented uncertainty,” Poloz said. “This approach does not mean keeping interest rates unchanged until inflation pressures emerge. That would virtually guarantee falling behind the inflation curve. Rather, it means following a more gradual approach to normalizing interest rates than traditional models would advocate, thereby balancing the risks around future inflation.”

In case you weren’t counting, Poloz used the word “gradual” twice in that short passage. You don’t talk like that if you are about to raise interest rates for the second time in two months. Unless the GDP numbers are off the charts, the Bank of Canada most likely take a pass in September.

Source: Financial Post

Bank of Canada Benchmark Rate, Mortgage Rates Canada, Mortgages & Real Estate, NonMortgage Debt, Variable Rate Mortgages

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