Bank of Canada governor Stephen Poloz says impact of oil drop still unclear

The impact of lower oil prices and how much they will hurt Canada’s economy remains unclear, but last month’s surprise rate cut gives the Bank of Canada time to figure out how best to steer the country back toward stability, bank governor Stephen Poloz said Tuesday.

LONDON, Ont. — The impact of lower oil prices and how much they will hurt Canada’s economy remains unclear, but last month’s surprise rate cut gives the Bank of Canada time to figure out how best to steer the country back toward stability, bank governor Stephen Poloz said Tuesday.

“The oil price shock itself is of uncertain size,” Poloz said in the inaugural president’s lecture at London, Ont.’s, Western University.

“So, the downside risk insurance from the interest rate cut buys us some time to see how the economy actually responds,” he said.

The quarter-point rate cut, which reduced the central bank’s overnight rate to 0.75 per cent, Poloz said has given policy-makers more confidence the economy should be back on a more sound footing by the end of next year, rather than some time in 2017.

Still, uncertainty remains because while the oil price shock hurt the economy almost immediately, taking advantage of a lower Canadian dollar to boost exports, and increased consumer spending on things other than lower-priced fuel, will only happen gradually, said Poloz.

And he warned that lower oil prices mean lower Canadian income, which will worsen the household debt-to-income ratio.

The Bank of Canada’s next interest rate announcement is March 4 and many had predicted the central bank will cut its key rate by another quarter of a percentage point.

However, some started to question that forecast following the central bank governor’s speech.

With his comments Tuesday, Poloz is “setting up a heretofore unexpected pause at next Wednesday’s (central bank governor’s) meeting,” Scotiabank economists said in a statement.

“In our view this says that the Bank of Canada is shifting to data dependency and will condition further possible easing upon how the data and market metrics like oil prices evolve over time,” Scotiabank said.

In response to questions after his speech, Poloz said he sees near-term positives in Canada’s economy that could impact the central bank’s decision making, including the price of Brent crude oil stabilizing in the range of $60 US.

And he later told reporters the economy might not see the positive effects of lower oil prices and interest rates until “later this year.”

One lesson Poloz and other central bank leaders have learned from the recent recession is that interest rates are not very effective in mitigating economic crises.

That said, real interest rates are likely to remain relatively lower than in the past for some time to come, largely as a result of the aging population, Poloz said.

“We have learned that interest rates associated with two per cent inflation leave very little room to manoeuvre in response to large shocks,” he said.

The governor also called for a reinvention of central banking that integrates both inflation and financial stability risks.

Poloz said the global financial crisis and recession showed that low and stable inflation does not guarantee financial stability.

“We need to take account of a wider range of economic and financial consequences while targeting low inflation,” he said.

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