Incoming Bank of Canada governor Stephen Poloz should raise interest rates, a new report says.
Advice for incoming BoC governor: Raise interest rates
Report says low levels have threatened pension funds, helped boost household debt
Julian Beltrame The Canadian Press
The C.D. Howe Institute says in report authored by economist Paul Masson, a former special adviser to the central bank, that after five years of super-low interest rates, it is time to take the anemic economy off its meds.
He says an extended period of low interest rates is introducing pervasive problems into the economy, such as asset bubbles in housing and risk-taking and inefficient investments.
As well, low interest rates are threatening the sustainability of pension funds and contributing to record high levels of household debt.
Masson notes that other countries also have near zero policy rates, but says Canada is not in the same position as the United States, Japan or Europe.
The economic recession of 2008-09 didn’t hit Canada as hard, he says, and with gross domestic product near the economy’s capacity, the current one-per-cent policy rate no longer is justified.
Raising rates may increase the value of the Canadian currency and set back exports, Masson concedes, but adds that with the U.S. economy in recovery mode and the dollar already below parity, the manufacturing sector can cope with a modestly stronger loonie.
If you were Stephen Poloz, would you raise or lower interest rates?
by Erica Alini
Newly minted Bank of Canada Governor Stephen Poloz will be answering questions from MPs Thursday in his first testimony before the Standing Committee on Finance. There have been a few photo-ops, but so far we haven’t heard much from our new central banker. This is Poloz’s first chance to give us a hint of what he has in mind for Canada’s monetary policy. The question that’s on everyone’s mind, of course, is: Which way will interest rates go? The next interest rate announcement until July 17 but everyone will be looking for hints tomorrow that indicate which way the BoC’s new boss is leaning.
The Bank of Canada sets the so-called policy rate, which is the average rate the BoC wants to see banks using when they lend money to each other overnight. The key policy rates influences commercial interest rate, such as those charged by mortgages providers, and has been set at one per cent since September 2010. Anyone who remembers where interest rate were in the 1980s—which wouldn’t be this correspondent—knows how incredibly low one per cent is (in 1981 the BoC was at one point charging over 20 per cent interest on loans to other financial institutions). But interest rates throughout the developed world are at rock bottom right now. Central bankers slashed them during financial crisis to encourage borrowing and investment—and, in the U.S., likely also to limit homeowners’ defaults. The fact that they’re still so low is a testament to how slow the global recovery has been.
Interest rates, though, aren’t just the cost of borrowing: They’re also the reward that savers get for lending their money (a reward has been dreadfully small for quite a while now). Generally, raising interest rates attracts capital because some investors will move some of their money to where they can get better returns. Higher interest rates in Canada means that there will be more demand for the Canadian-dollar assets, which increases the price of the loonie relative to other currencies. An appreciation of the Canadian dollar, in turn, makes Canadian exports less competitive.
Now, an actual interest rate raise would be quite a bold move considering that the global economy is still sputtering, meaning that demand for Canada’s exports is rather weak. On other other hand, lowering the policy rate could be equally risky, as it might further encourage borrowing at a time when Canadian household owe $1.65 for every dollar of disposable income and housing prices are at record highs.
Poloz’s predecessor, Mark Carney, kept the policy rate unchanged for almost three years but had long been promising that the Bank would eventually raise rates, something economists call “a tightening bias.” Poloz’s choice, then, many economists suggest, is really between maintaining Carney’s tightening bias and eventually hiking up rates in late 2014 or early 2015, or removing that bias and keeping rates where they are for the foreseeable future.
What would you do? Take a our survey at the bottom of this page! To help you make up your mind, below is a list of recent economic data and studies that could be as reasons to maintain the bias or to drop it. (They’re by no means exhaustive lists.)
Reasons for keeping the tightening bias:
- Consumers are still piling on debt, according to the latest statistics, but at a slower pace. The BoC’s promise that interest rates will eventually rise might have contributed to moderate borrowers.
- Canada has the third most overvalued housing market in the world, according to a recent OECD study that measured residential real estate prices against both incomes and rents. Ottawa tightened mortgage rules last year in an attempt to cool the market, but similar rounds of tightenings have onlytemporarily discouraged home buyers in the past.
- Raising the cost of borrowing (higher interest rates) has a cooling effect on economic growth, whereas lowering interest rates is generally an economic stimulus. Now, Canada’s economy grew at 2.5 per cent of GDP during the first three months of 2013, faster than expected. Why add stimulus now by eliminating the tightening bias, supporters of the status quo might say?
- Exports to the U.S. are growing, thanks in no small part to the housing market recovery down south.
- Keeping interest rates low for very long periods can channel capital to the wrong corners of the economy, as investors turn to risky investments in order to earn some decent returns, argues a recent paper (pdf) by the C.D. Howe Institute. Low-for-long rates might also end up bankrolling “zombie companies,” i.e. uncompetitive enterprises that would not survive if the cost of borrowing was higher and suck up resources that should go to worthier firms, the study says.
Reasons for dropping the tightening bias:
April was the 16th consecutive month in which Canada recorded a trade deficit. Exports to the U.S. might well be recovering, but our exports to the rest of the world took a dive, the latest data from Statistics Canada shows.
With consumers maxed out and the housing market cooling, exports have been the main source of growth in the first quarter of 2013.
Canada might have well recorded decent growth between January and March, but it good to remember that GDP expanded by a dismal 0.9 per cent in the last quarter of 2012. If the U.S. economy slows as a result of the automatic spending cuts approved by Congress and the White House earlier this year, Canada might follow.
House prices might still be very high, but home sales have generally been declining after Finance Minister Jim Flaherty further tightened mortgage rules a year ago. It could be a sign that the government’s efforts are working this time.
But it doesn’t look like the new BoC boss is position to change the status quo … not yet.
New Bank of Canada chief says interest rates will remain low, for now
Governor of the Bank of Canada Stephen Poloz appears before the House of Commons Standing Committee on Finance on Parliament Hill in Ottawa on Thursday June 6, 2013 regarding his appointment as the new Governor of the Bank of Canada. THE CANADIAN PRESS/Sean Kilpatrick
New Bank of Canada governor Stephen Poloz is signalling there will be no shift from the current low interest rate policy under his leadership, at least in the short term, despite fears it is creating imbalances in the economy.
Although keeping rates low for a long period has a distorting impact on the economy, including triggering excessive borrowing, Poloz says the central bank must also consider the risk to the fragile economy of raising rates too soon.
“My concern is we do the right thing so this (weak economy) doesn’t last for a generation,” he told the Commons finance committee Thursday.
“For now … we don’t see that those risks (from low rates) are manifesting themselves in a threatening way.”
Scotiabank economist Derek Holt said if anything, Poloz’s testimony suggests that he may be even more dovish toward monetary policy than Carney, pointing out the emphasis on the bank having a role “nurturing” economic growth.
“A speech that is all about ‘nurturing’ and the Bank of Canada’s role in building confidence through this process suggest a policy leaning toward at least a less hawkish (bank) than under the last months of Carney’s tenure,” Holt wrote in a note to clients.
He said one possible ramification may be that the bank may soften, or drop altogether, its persistent warning that the next move will likely be higher interest rates at its next policy pronouncement on July 17.
Several other analysts said it was probable that July would bring no material change in the bank’s policy to keep the trendsetting interest rate at one per cent, leading to some of the most favourable borrowing conditions in many decades.
The Canadian dollar jumped more than a penny to 97.85 cents US following the testimony, but analysts said the prime cause was U.S. dollar weakness.
The two-hour appearance was a first chance for MPs to probe the new governor, who took command of the central bank this week, for any divergence with his predecessor Mark Carney, who takes over the Bank of England in July.
Poloz provided some evidence that he doesn’t see the world exactly the same way, and also that he may be a different governor, one more likely to restrict his views to strictly bank business than his free-wheeling predecessor
For instance, he said he would not characterize the build-up of cash reserves by corporations as “dead money,” as Carney did in urging firms to invest.
Noting Carney himself has since declared it “resurrected,” Poloz said he would characterize firms as having “healthy balance sheets.”
“And that’s a good thing,” he said. “The process (of recovery) would be much more difficult if foreign demand is building, and our confidence gets up, and we don’t have balance sheet available to do the job, then we have a different problem. One of the most importance ingredients to getting the investment momentum we expect to see is having a healthy balance sheet and being ready.”
Asked about Carney’s publicly stated concern for income inequality, Poloz said the issue is of interest, but: “As a central bank, we only have a modest influence.”
The new governor did show signs of having some of his predecessor’s sense of flair, however, describing the current recovery not as a normal climb-back from a deep recession, but something akin to a “post-war reconstruction.”
The 2008-09 crisis was so damaging that the world needs to reconstruct its financial system, he explained. For Canada, it put some firms out of business and caused others to permanently downsize.
“In effect, the recession caused a significant structural change in the Canadian economy,” he said. “In short, we need to see the reconstruction of Canada’s potential, and a return to self-sustaining, self-generating growth.”
The first step to that process is a recovery in export markets, something he said was under way, notably in the United States and Japan.
He also agreed with his predecessor that Canada’s commodity riches are a net benefit to the economy, dismissing even his own 2005 concerns about Dutch disease as no longer applicable.
Poloz, who had been a surprise pick for governor by Finance Minister Jim Flaherty, also dealt directly with the issue of the bank’s independence, particularly over a recent government action that requires Crown agencies, including the central bank, to in essence clear hiring decisions and salaries with the Treasury Board.
That will not in any way impact the policy independence of the bank, Poloz insisted.
“I see a clean separation between administrative independence and monetary policy independence,” he said.