OTTAWA — Bank of Canada governor Mark Carney is expected to show his hand Tuesday on whether he believes the economic recovery is rooted enough to withstand an increase in interest rates.
The consensus among economists is that Carney is itching to move off the 0.25 per cent lower bound, but will hold off until July in part because of his “conditional commitment” to hold firm until the end of the second quarter.
But, a growing minority believes June 1 is now likely in part because the market has already priced in the hike.
The argument goes like this.
Inflation has been higher than the central bank had forecast and the economic bounce — five per cent in the fourth quarter and about six per cent expected in the first quarter — has been bigger. To delay would risk a bout of inflation and controlling prices is the bank’s principal function.
Canadians appear to have bought the argument, judging from the 100,000 or so that put their homes up for sale last month — the biggest March on record — in what was interpreted as an effort to get ahead of higher mortgage rates.
But there are those advising Carney to also let the July 20 date go by.
“Why punish the economy for growing?” asks Carl Weinberg of U.S.-based High Frequency Economics, who thinks the bank should wait out the year.
“Even though there has been some economic growth, it has been minimal. The activity levels of the economy show it is still quite depressed compared to the peak levels of output demonstrated two years ago (and) full employment is not anywhere in sight.”
Royal Bank chief economist Craig Wright also doesn’t believe July 20 is written in stone, although he thinks that is the most likely move date.
If there is a risk to the consensus, Wright says, it should be toward waiting longer, noting that the global recovery remains fragile.
While Carney’s language has become more hawkish of late — suggesting he is setting the stage to raise rates — he has also advised in the past that the end of the commitment doesn’t necessary mean the bank will raise rates immediately after.
The justification for waiting is not that the economy isn’t growing, nor that core inflation hasn’t proven more stubbornly “sticky” than expected — it rose to 2.1 per cent in February, a tick above the bank’s target — but that more damage can be caused by moving too early than too late.
Wright points out that with excess capacity still in the economy and unemployment rate at 8.2 per cent, two points higher than pre-recession levels, the risk of inflation setting in is minimal. In fact, he expects core to drop to 1.8 per cent when the March data is announced on Friday.
“If they go too early, you get the risk of a double-dip and if they wait too long, you run the risk of inflation. To the extent the authorities play the risk, they would probably play the risk of running more inflation than flirting with deflation,” he explained.
Raising rates could jeopardize the recovery by slowing down borrowing and as a consequence spending, adding drag to an economy already facing the end of government stimulus and global uncertainty over debt financing.
“Oh yes, and is anyone thinking about how much damage the strong loonie is doing to the economy?” adds Weinberg, noting that raising rates before the U.S. will only strengthen the Canadian dollar.
Bank of Montreal economist Michael Gregory is also skeptical about how real the threat of inflation is in the medium term.
But he believes Carney will indeed move off the lower bound, not in June but in July, if only to prevent the irresponsible behaviour that occurred earlier in the decade when low interest rates fed the U.S. housing boom.
“There are risks of financial instability to keeping rates too low for too long,” he says. “Maybe it will lead to excessive risk-taking in the economy, excessive debt build-up and perhaps fuel an asset bubble.”
He notes that the Bank of Canada has already sounded the alarm about household debt, which is at a record of 147 per cent, and the hot housing market.
Whichever way Carney is leaning will almost certainly be revealed this week, says CIBC chief economist Avery Shenfeld, when the bank issues updates for both the economy and inflation.
Shenfeld says Carney won’t be tipping off the exact date the bank will start raising rates, but may signal that a tightening phase for the second half of the year.