The sun was out and there was a definite hint of spring in the air. I was feeling pretty good and optimistic about life after coming in from a walk. Then I flipped open my laptop and listened to the Governor’s press conference following his speech in Oshawa. Wow. What a downer this guy is becoming and, to boot, he is getting a bit testy when asked about his cautious tone. It must be frustrating when the mere mortals that make up the economy do not understand the grave danger this economy is in at the present time.
In brief, there is no change in the Bank’s very dovish view. The Governor would not even rule out the possibility of rate cuts despite seeing the same positive economic news as the rest of us. He even told us that a return to normal rates at this point would cause a recession, although no one I know has suggested that he rapidly push up rates.
He reminded us all that the Monetary Policy Report is coming out in a few weeks and he will give us his updated assessment then. However, I would wager that a few weeks are not going to materially change his bias. Any stronger growth will have reduced excess capacity but it will not have closed the gap. Against that backdrop, the Governor will stress that core inflation stubbornly remains below target. Most importantly, the elephant in the room has not left. It is unlikely that there will be any greater clarity around the timing and specifics of possible US protectionist measures between now and then.
So apart from the Bank being downbeat and remaining dovish, what else did we learn in the press conference and speech?
We received a concise history of the Canadian economy that highlighted the importance of trade to the country.
The Governor explained to us that the negative impact from any protectionist’s measures is ridiculously difficult to quantify as behavioural changes and linkages at the micro and macro level are just too complex. We now know that certain types of increases in protectionism can be modelled, but the degree of uncertainty around the outcome is huge, as in Donald Trump “huge”. So the potential for a very large negative outcome exists. The Governor could be uttering a Draghi-like “whatever it takes” to a business audience soon (or not).
The Governor revealed his thoughts on housing prices. Apparently, the Bank’s concerns and the actions of various federal government agencies have never been directed at affordability, slowing down the increase in housing prices. Those nasty increases in the GTA have come about from simple demand/supply dynamics specific to the area. Strong economic growth in the Toronto region, coupled with immigration are just too much for the available supply. The Governor did say that there may be some expectational (speculative) buying starting to appear, but that will be monitored. I am not sure why. After all, there is nothing the Bank nor OFSI nor DoF can do about that. Nope, their focus has been on creating the firewall that will ensure that if residential home prices fall, any negative feedback to the financial system will be contained. When analysts or the media look at ever rising housing prices in the GTA and then conclude the measures taken to date have been ineffective, they are using the wrong metric. The new rules are helping ensure that the lenders and the borrowers are in a better position to absorb any shock. As long as stupid prices are not being financed by our financial system, but rather by the bank of mom and/or dad or foreigners, then there is little risk to the economy associated with stupid prices correcting.
I continue to struggle with the idea that there is zero risk that a sharp decline in housing prices for a third of the Canadian population will have no negative impact on economic activity and hence on inflation. The amount of economic resources that have been attracted to housing related activity, let alone any notion of a wealth effect influencing spending do not appear relevant for the Bank’s outlook. Maybe Canada will be “lucky” as the US was in the tech crash of 2000 where the economic fall out of the NASDAQ’s melt down was limited and contained. But I would point out that monetary policy actions were taken following that crash to clean up.
What I will take from the Governor’s comments on the housing market is that he remains determined to keep it a financial stability issue and out of monetary policy deliberations. At the upcoming April meeting, given the risk management framework used when setting policy, they will discuss how much risk weighting they should give to potential US trade measures negatively impacting inflation over the forecast horizon. They will try to quantify something that may or may not happen at some point in the future, neither knowing if protectionist measures will ever be reality, their extent nor the magnitude of any negative impact even if they are implemented. At the same meeting, there will be no discussion of any possible impact to the economy from a housing price correction in the GTA, a risk that is currently based in reality and building daily, in part driven from “expectational” buying.
So looking at these risks, what most likely comes first? Sufficient clarity on US trade policy or a correction in housing prices in the GTA?
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