This week the Bank of Canada had the opportunity to revise its dovish message via a speech given by Deputy Governor Shembri on business investment. They chose not to budge. They continued to downplay any recent positive global and domestic economic data, focusing instead on the large difference in the size of the Canadian output gap versus that of our southern neighbour. The Bank remains highly skeptical that Canada “is out of the woods yet”. Too many false starts over the last few years (“serial disappointments”)have obviously scarred Governing Council and has them concerned that the rug will be pulled out from underneath them again.
Like Bambi staring at the oncoming car lights, the Bank appears frozen, transfixed on geopolitical risks that may include protectionist measures taken against our exports by the new Trump administration sometime in the future. I am sure their anxiety has even been amped up further following the US refusal to refute protectionism at the recent G-20 meeting, and given hints that the administration is preparing to soon issue the 90 day notice of their intension to revise NAFTA.
In the meantime, the economy keeps marching on, apparently having found its footings. The speech mentioned that the worse may be behind the energy sector, that government stimulus will lend support, and that the service side of the economy will contribute to any expansion. Growth now seems likely to exceed what was outlined in the January MPR when they saw growth at over 2% in 2017 and 2018, above their estimate of potential in both years.
While the economy moves forward, roughly one third of the population remains subjected to a housing market that refuses to cool. Any macro prudential measures that have been taken by the federal government and its agencies to date have not been effective. Recent comments by the Minister of Finance suggest a reluctance to impose more restrictive federal policies on the entire country when it is just a few isolated areas in the country that are experiencing the bubble in prices. Apparently the fiscal tools at the government’s disposal are just too blunt….so over to you at the provincial level. Yes, you. The one with a 12% approval rating.
The Governor will tell anyone who listens that monetary policy decisions are made within a risk management framework. His dovish leanings would suggest that he is convinced the economy is operating with significant excess slack and so the downside risk to inflation of a geopolitical event slamming our exports is greater than any significant upside risk to inflation from a stronger than expected economy. The recently published inflation numbers probably embolden this view for now. But timing is involved. The longer it takes to get greater clarity around trade, the more time the economy has to close the output gap and the calculus changes. At some point, he may have to increase rates, forcing him to later save the exporting community by cutting rates from a higher starting point.
In the meantime, what harm is there in keeping rates exceptionally low and keeping downward pressure on the currency? It is an easy decision when you put zero weight on the risk of a housing price collapse impacting inflation. Maybe Governing Council attended the recent Tony Robbins and Pit Bull real estate conference held in Toronto where folks were assured prices can only go up. Whatever their reasons, in the speech where the Bank outlines the upside and downside risks to inflation, there is no mention of what is going on in that sector. Why would they (I ask sarcastically)? I understand that normally the housing market is supported and is vulnerable to the underlying economy. Their own stress tests show how devastating a loss of employment would be to this sector. I get it. But with each passing day, housing prices get further away from justifiable levels, having parted ways with the macroeconomic fundamentals that have traditionally explained movements in housing prices. When asset prices become warped, does causality remain one-way? I personally find it hard to believe that there is zero risk that a collapse in housing prices, impacting a third of the population will have no impact on the overall economy and, hence, inflation. I would have thought that is one lesson policy makers would have taken away from the US housing fiasco. But no, in Ottawa this remains a vulnerability to be discussed only in the Financial System Review. In other words, it is no doubt a concern, but in their view, certainly not anything that can be addressed with monetary policy. Better to clean up the mess afterwards than lean into it now with higher rates. (Again, sarcasm.)The interest rate tool is just too blunt of an instrument ( and where have I heard that before). Apparently, implicit in the Bank’s actions, with inflationary expectations well anchored, this tool should only be used to keep pressure on the currency to support non-energy exports.
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