Last week Bank of Canada (BoC) Governor Poloz threw cold water on growing speculation that the BoC’s next rate move will be a cut.
In his speech in Iqaluit, Nunavut, Governor Poloz reiterated his view that our current slowdown will prove temporary. While current Government of Canada (GoC) bond-yield levels indicate that bond-market investors are more pessimistic, when the person with his hand on our policy-rate lever offers his views, we are wise to pay heed.
Here are the highlights from Governor Poloz’s most recent speech:
- He observed that global economic momentum continued to be slowed by trade uncertainty, which also led to “weaker-then-expected” growth for our economy late last year.
- He acknowledged that our energy sector continues to adjust to lower oil prices, but also observed that the negative economic effects associated with that ongoing adjustment are being partially offset by “fast growing service industries”.
- Governor Poloz reiterated the fundamental importance of exports to our economy and noted that export demand in our service sectors is growing at about twice the rate of our overall economy.
- While our economy’s transition from natural-resource-led export growth to service-sector-led export growth is healthy, it is also one of the “important structural changes” that is muddying the BoC’s current inflation outlook.
- Governor Poloz noted that economic shocks tied to trade wars beyond our borders can be offset by a reduction in our existing inter-provincial trade barriers. He estimated that lowering these barriers “could add $4.5 billion every year to Canada’s potential growth”.
- He noted that factors such as slowing trade and investment spending combined with our economy’s adjustment to lower oil prices and slower housing markets “continue to warrant a policy rate that is below its neutral range.” (As a reminder, our policy rate is currently 1.75%, and the BoC’s estimated neutral-rate range is currently 2.5% to 3.5%.) That said, he also reiterated his belief that “recent economic data have been generally consistent with our expectation that the period of below-potential growth will prove to be temporary.”
So, should we now put to rest the idea that the BoC’s next rate move will be down?
Not so fast.
While it’s true that Governor Poloz has his hand on our policy-rate lever, as I recently wrote, what he wants and what he needs are not the same thing.
Governor Poloz would like to continue raising our policy rate if it means that our economic momentum is gathering speed and our economy has successfully transitioned through oil-price and interest-rate adjustments. But as he recently reminded us, the BoC’s sole mandate is to maintain price stability. If our economy continues to experience below-target inflation, more BoC rate hikes won’t be in the cards and rate cuts won’t stay off the table.
Here are some thoughts on why our current slowdown may prove more persistent than Governor Poloz believes:
- Our economy has not yet experienced the full impact of the five quarter-point BoC policy-rate hikes that began in July 2017. The Bank estimates that it can take up to two years before each hike realizes its full impact, and that means that our economy’s current rate-hike headwind is likely to intensify over the remainder of 2019 and won’t fully dissipate until late 2020.
- The BoC acknowledges that consumer spending is now slowing, and it hopes that exports and business investment will take up the slack (which is a tall order when you consider that exports and business investment together account for about half of what consumer spending contributes to our overall GDP). Our export sales have been in a downtrend since mid-2018, and it’s hard to believe that rising demand for service-based exports will drive the same resurgence in business investment that we would traditionally see in resource-intensive sectors, which remain mired in a slump.
- While our headline employment data impressed in early 2019, there has been virtually no employment growth in the manufacturing sector over the past twelve months. That is concerning because manufacturing employment fuels job growth across our broader economy. It should be noted, however, that employment data are lagging indicators, telling us more about the past than the future. While recent employment data have been mostly strong, our leading indicators, which tell us more about where our economy is headed, have shown slowing momentum for some time now (excepting the initial estimate of 0.3% GDP growth in January, which was an upside surprise). This disconnect between the employment data and our leading indicators will eventually be resolved one way or another, and my money is on the latter winning out.
- The U.S. economy, which buys about 80% of everything we export, is losing momentum fast. The tax cuts and stimulus spending that the U.S. federal government enacted in early 2018 gave the U.S. economy a sugar-high that has fizzled quickly. On an annualized basis in 2018, U.S. GDP growth spiked at 4.2% in Q2 before dropping to 3.4% in Q3 and to 2.2% in Q4. It’s hard to be bullish about Canadian export growth when the U.S. economy is slowing sharply.
- Governor Poloz highlighted our floating exchange rate as a tool that can “help the economy adjust to shocks” but thus far, the Loonie has proved surprisingly resilient against the Greenback and is providing little relief to our exporters’ ongoing “competitiveness challenges”. To wit, the Loonie closed at $0.75 USD on Friday after bottoming out at $0.73 in late December, when our economy was reeling from the most recent oil-price shock. Even an exchange rate of $0.73 USD is considered expensive in the current environment, so the Loonie’s shock-absorbing potential has thus far not materialized.
The Bottom Line: In his speech last week, BoC Governor Poloz predicted that our current economic slowdown will prove temporary, and he threw cold water on the bond market’s growing belief that the Bank’s next policy-rate move will be a decrease. For the reasons outlined above, I think that the current slowdown will last longer than Governor Poloz forecasts and that our fixed and variable mortgage rates aren’t likely to move materially higher this year. Furthermore, I continue to believe that the BoC’s next move is still more likely to be a cut.