If not for Donald Trump, the Bank of Canada probably would be raising interest rates.
But Trump exists, and the U.S. president’s assault on the norms of global trade is so severe that the central bank has little choice but to leave borrowing costs unchanged, lest it add to the chaos.
“Trade policy developments are an important and growing source of uncertainty for the global and Canadian outlooks,” the Bank of Canada said in summing up its latest round of policy deliberations, which ended with a decision on Wednesday to leave its benchmark lending rate unchanged at 1.25 per cent.
That wasn’t a surprise.
When the Bank of Canada raised the target rate a quarter-point in January, it said it was worried about what Trump’s intentions for the North American Free Trade Agreement might be doing to the psyche of executives.
Trump’s decision to tax imports of steel and aluminum can only deepen that concern. The latest round of talks to overhaul NAFTA ended in Mexico City this week without a timeline for resolution.
“While the economic outlook is expected to warrant higher interest rates over time, some continued monetary policy accommodation will likely be needed to keep the economy operating close to potential and inflation on target,” the central bank said in its statement. “Governing Council will remain cautious in considering future policy adjustments,” the statement said.
Those words are repeats from the previous policy announcement, suggesting the central bank’s outlook remains essentially unchanged, despite recent data that confirmed Canada’s gross domestic product expanded an impressive 3 per cent in 2017.
Bay Street and Wall Street will now attempt to divine when Governor Stephen Poloz and his inner circle of advisers on the Governing Council will follow up on their promise of higher interest rates.
There is a split among the closest observers of monetary policy over when that might happen.
Most are like Brett Ryan, an economist at Deutsche Bank in New York, who advised his clients on March 5 to expect a couple of quarter-point increases this year, which would leave the benchmark lending rate at 1.75 per cent by the end of year. They point out that Canada’s GDP was growing about twice as fast as the central bank reckons the economy can grow without stoking price increases, suggesting policy makers are at risk of losing their grip on inflation.
But there is a minority that includes Aubrey Basdeo or BlackRock Inc. and Sebastien Lavoie at Laurentian Bank Securities that says Canada’s economy will need low interest rates to push through serious economic headwinds, including uncertainty over trade rules and weaker consumer demand. Basdeo and Lavoie said before the latest policy announcement that the central bank likely will increase interest rates only one more time in 2018.
To be sure, the vibe around the Canadian economy has changed markedly in recent days. For much of last year, the data seemed too good to be true. GDP surged to annual rates of around 4 per cent over the first half of 2017, as oil prices rebounded from collapse.
And of course, data were too good to be true.
Growth rates came back to earth over the final months of last year, as the central bank and economists predicted they would. Still, the slowdown was sharper than most predicted. GDP advanced at an annual rate of 1.7 per cent in the fourth quarter, Statistics Canada reported last week; that’s in line with the economy’s non-inflationary speed limit, but significantly less than the 2.5-per-cent rate the central bank predicted in January.
The Bank of Canada acknowledged the weaker output at the end of last year, explaining it as the result of a surge in imports and sluggish exports. (Exports add to GDP, while imports subtract from it because they represent money leaving the country.) However, policy makers expressed little concern, describing higher imports as reflecting stronger business investment, “which adds to the economy’s capacity.”
Investment is a key indicator for Poloz. Another is wages. The unemployment rate is near its lowest in decades, and the governor has suggested that the economy probably is close to full employment, or the point at which a lack of idle workers will put upward pressure on salaries and therefore inflation.
But data indicate that wages only recently have started to turn upward after a long period of stagnation. Poloz has said repeatedly that he is tempted to let the economy run a little hot so long as wage pressures remain muted. The central bank appears still to be leaning that way, although the runway could be getting shorter.
“Wage growth has firmed, but remains lower than would be typical in an economy with no labour market slack,” the statement said.
Firming wage growth normally would be a signal that interest rates were headed higher. Not right now; not until Canada comes up with a way to offset the Trump effect.
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