OTTAWA — Bank of Canada governor Mark Carney likely has the easiest decision Tuesday since becoming the country’s central banker — do no harm.
With economic and job growth stalled, and the loonie partying like it’s 2007, Carney seriously risks undermining the recovery with yet another interest rate hike if he decides to boost borrowing costs at the central bank’s next rate meeting.
There are already a growing number of critics who wonder if it was wise to hike the policy rate three times during the summer months to one per cent, which while super-low is still one per cent higher than the U.S. Federal Reserve setting.
A survey of economists last week found over 90 per cent agreeing that Carney has nothing but explaining to do on Tuesday, particularly explaining why despite numerous downward revisions, economic reality keeps proving to be even worse.
But while Tuesday’s decision is a no-brainer, the times become much more interesting for Carney after that, say analysts.
“There’s a very active debate about when the bank should start raising again that ranges from as early as January next year to sometime in 2012,” says Douglas Porter, deputy chief economist with BMO Capital Markets. “That’s a wide range.”
Those arguing for a January increase cite Canada’s surprisingly sticky inflation rate, which rose to 2.4 per cent in October. Even underlying core inflation, at 1.8 per cent, is elevated in an economy two years removed from returning to full capacity.
The doves say one per cent is the appropriate number, reflecting stronger conditions than in the U.S., while remaining mildly stimulative.
The range of policy options may be even wider, however. Capital Economics analyst David Madani says Carney should not rule out reversing course altogether, and cut the policy rate if conditions don’t improve.
There is clear evidence that the loonie, which is directly affected by the difference between U.S. and Canadian interest rates, is exerting serious damage, he says.
Despite the sharp downturn in Canada’s economic growth to a meagre one per cent in the third quarter, the weakness has not translated into a softer currency as normally would be expected.
Instead, the loonie was again threatening to push through parity with the U.S. greenback Friday, as it has for much of the year.
Analysts, such as David Rosenberg of Gluskin Sheff , believe the loonie is at least five cents too rich for the fundamentals, and although many factors are at play, the interest rate differential with the U.S. is one of them.
A strong domestic currency encourages imports and discourages exports, the opposite of what countries want to achieve, and the evidence is mounting that is precisely what is happening in Canada, says Madani.
Last week’s reported quarterly record $17.5 billion current account deficit, including the deteriorating trade balance with the United States, was one wake-up call.
So was Friday morning’s November jobs data that saw another 29,000 jobs vanish in manufacturing, an industry that depends heavily on exports of cars, parts, lumber and machinery to the U.S.
“What’s happening in net trade has got to get the Bank of Canada a little nervous,” says Madani. “They have to wonder if the summer rate increases were a mistake.”
Few, including Madani, expect Carney to reverse course, unless the floor gives way on the economy.
For one thing, says Porter, central bankers are human and hence reluctant to admit mistakes.
And it is far from certain the three small rate increases in recent months have had any appreciable impact on the economy, except the desirable outcome of reminding would-be home buyers that interest rates will someday rise and they should take care they can afford to take on additional debt.
Other factors, particularly the flight of money out of U.S. and Europe to relatively safe Canada, as well as firm commodity prices, are more important to the loonie’s trading value than interest rates.
Lastly, although the bank’s policy rate hikes has increased the short-term cost of borrowing, five years mortgages are just as low in Canada today as they were before the bank actions.
The most important factor, however, says Scotiabank’s Derek Holt, is that a policy reversal may actually do more harm than good.
“The shock that would have in terms of consumer and business confidence would arguably be greater than any gain to household borrowing from a 50-basis point cut,” Holt explained.
Porter says the economy is not there yet, in terms of needing another boost of monetary stimulus.
Economic and jobs growth is sluggish, but it is still on the positive side of the ledger, he points out. And the prospects in the U.S. appear to be improving, judging by the 2.5 per cent advance in the third quarter, and better manufacturing data.
But in this climate of high uncertainty, “I wouldn’t rule it out completely,” he adds.