Bank of Canada Considers Insurance Rate Cut, But Rejects It For Now

(Bloomberg) --

Bank of Canada Governor Stephen Poloz, one of the few central bankers to resist the global push toward easier monetary policy, acknowledged he’s begun to consider the merits of joining other countries in lowering borrowing costs

At a press conference after the Bank of Canada’s decision to keep the current 1.75% policy interest rate unchanged for an eighth straight meeting, Poloz said his governing council discussed the possibility of implementing an “insurance” cut to counter global economic headwinds, but decided against it because of the potential costs to such a move. These include driving up inflation already at the central bank’s 2% target, and fueling household debt levels that are among the highest in the world.

“Governing Council considered whether the downside risks to the Canadian economy were sufficient at this time to warrant a more accommodative monetary policy as a form of insurance against those risks, and we concluded that they were not,” Poloz said. The Bank of Canada “is mindful that the resilience of Canada’s economy will be increasingly tested as trade conflicts and uncertainty persist.”

While the decision to remain on hold for now will cement Poloz’s status as an outlier, markets will interpret his comments about an insurance cut as an attempt to lay the groundwork for a future move if the domestic economy deteriorates. Earlier, the central bank released a rate statement that was more dovish than other recent communications, along with a set of reduced growth forecasts.

Market Reaction

Canada’s currency fell as much as 0.8% after the decision, the most in almost a month, trading at C$1.3178 against the U.S. dollar at 12:11 p.m. Toronto time. Two-year government bond yields dropped 13 basis points to 1.58%. Investors are assigning a 75% chance of a quarter-point cut in the next 12 months, versus less than a 50% chance before the statement.

“The Bank of Canada held its target overnight rate unchanged, as expected, but with a slightly more dovish tilt,” Brett House, deputy chief economist at Scotiabank, said by email. “While not entirely setting up a cut at its next meeting, this leaves open the door a bit further for a December cut.” The next rate decision is on Dec. 4.

Doug Porter, chief economist at Bank of Montreal, said in a note to investors that the Bank of Canada appears to have adopted a “bias to cut rates, and we may be just one more serious global trade accident away from them acting on the bias.”

By holding steady, Canada will be left with the highest policy rate among advanced economies if the Federal Reserve cuts later Wednesday, as expected. That raises the question of whether the northern nation’s economy is truly strong enough to justify the distinction.

The Bank of Canada is bullish on consumption and housing -- which are being fueled by a robust labor market. Wage gains are accelerating, now hovering at around 3%, a level consistent with an economy at full capacity. Global financial conditions meanwhile have eased, helping offset the impact of growing trade uncertainty, officials said Wednesday.

Another source of future growth, meanwhile, could be additional stimulus from Prime Minister Justin Trudeau’s re-elected Liberal government, which has promised to implement new spending and tax cuts next year. The central bank is projecting inflation will remain at the 2% target over the projection horizon, and expects the nation’s “modest” levels of economic slack -- primarily in oil-producing regions -- will dissipate.

“We will pay close attention to the sources of resilience in the Canadian economy, notably consumer spending and housing activity,” said Poloz. “We will also be watching for any changes to fiscal policy at the federal level now that the election is behind us.”

What Our Economist Says

The statement and Monetary Policy Report “reinforces our view that the Bank of Canada is likely to make a modest downward adjustment to the policy rate by early 2020 -- or even as soon as December.”

--Andrew Husby, Bloomberg Economics (click here for the full note)

At the same time, the central bank has clearly concluded the global trade tensions have become a serious threat to the nation’s feel-good story. The central bank on Wednesday highlighted the impact of trade conflicts and uncertainty on global growth which officials said is hurting business investment, exports and commodity prices, even with global monetary easing.

The bank lowered its growth forecast for Canada to 1.7% next year, from a July estimate of 1.9%, and 1.8% in 2021 from a previous projection of 2%. It also forecast an outright decline in exports and business investment in the second half of this year, when growth is expected to average a sluggish 1.3%. As a result, the level of economic output will be “slightly lower” at the end of 2021 than predicted in July.

Officials also noted -- in a rare reference to the Canadian dollar in a rate statement -- that “despite” lower commodity prices, the currency hasn’t weakened against the U.S. dollar and is actually stronger against other currencies. While Poloz chose to cite the costs of cutting in his opening statement, one of the negative consequences of the Bank of Canada holding rates steady has been to drive gains in the Canadian dollar -- the world’s best performing currency this year.

--With assistance from Erik Hertzberg and Shelly Hagan.

To contact the reporter on this story: Theophilos Argitis in Ottawa at targitis@bloomberg.net

To contact the editors responsible for this story: Theophilos Argitis at targitis@bloomberg.net, Chris Fournier, Stephen Wicary

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