Recently the Bank of Canada (BoC) met and, as expected, left its
target overnight rate unchanged. More surprisingly though, the bank also
eliminated its oft-repeated warning about near-term rate increases.
Here is the exact wording from the announcement:
“While some modest withdrawal of monetary policy stimulus will likely
be required over time, consistent with achieving a two per cent
inflation target, the more muted inflation outlook and the beginnings of
a more constructive evolution of the imbalances in the housing sector
suggest that the timing of any such withdrawal is less imminent than
previously anticipated.”
The first notable wording change was the BoC’s “more muted inflation
outlook”, which was supported by the December Consumer Price Index
(CPI), released by Statistics Canada. The report showed overall
inflation of only 0.80 per cent over the most recent 12 months, along
with core inflation of 1.10 per cent over the same period. (Reminder:
core inflation strips out the more volatile inputs to the CPI like food
and energy prices.)
Our inflation rates have fallen steadily over the past year and a
half and are among the lowest in the world. If they remain at current
levels, the BoC will have to think seriously about lowering its
overnight rate, not raising it, to achieve a two-per-cent inflation
target over the medium term.
Sound crazy? Let’s look at the other key wording change in the BoC’s
latest statement – the “more constructive evolution of the imbalances in
the housing sector”.
Our borrowing has slowed sharply of late and household credit is now
expanding at a rate of only three per cent, the lowest level seen since
1999. If household credit growth, which BoC Governor Mark Carney has
repeatedly called the “greatest threat to our domestic economy”,
continues to stabilize, the BoC’s interest-rate policy should align more
closely with the actual economic data going forward.
I say this because I have long maintained that the bank’s repeated
warnings to Canadians about imminent rate increases have not actually
been supported by economic data, domestic or otherwise, for some time.
In fact, many analysts have long speculated that the BoC was using its
higher-rate warning as a kind of moral suasion to persuade Canadians to
slow their borrowing (a tactic that I would argue had little meaningful
impact).
Even if you look at the BoC’s own economic forecasts, which were just
updated in the latest Monetary Policy Report (MPR), there is plenty to
suggest that the next move in the overnight rate could just as easily be
down as up:
* The BoC cut its forecast for Canadian GDP growth from 2.40 per cent
to two per cent in 2013. (Note: the bank upgraded our GDP growth
forecast for 2014 from 2.40 per cent to 2.70 per cent but didn’t support
this optimistic revision with a detailed explanation. And it doesn’t
jibe with any of the bank’s projections for other countries in 2014, as
you will see below). The bank now also expects our output gap (the gap
between our actual output and our maximum potential output) to disappear
in the second half of 2014, instead of by the end of 2013, as
forecasted in the October MPR.
* The BoC cut its forecast for U.S. GDP growth from 2.30 per cent to
2.10 per cent in 2013 and from 3.20 per cent to 3.10 per cent in 2014.
The bank now estimates that “fiscal consolidation will exert a
significant drag on U.S. economic growth … (and this) will subtract
roughly 1.5 percentage points from growth in both 2013 and 2014.”
* The BoC cut its euro-zone GDP growth forecast from 0.40 per cent to
-0.30 per cent in 2013 and from one per cent to 0.80 per cent in 2014.
The bank now believes that “the economic recovery will be slower than
originally thought, in part because fiscal austerity measures and tight
credit conditions are taking a greater-than-expected toll on economic
activity”.
* The BoC takes note of China’s recent economic rebound but also
points out that “other economic activity has slowed further in other
major emerging economies.”
* On an overall basis, the report states that while “global tail risks
have diminished (meaning the risk of a systemic shock to the global
financial system that could be caused by an event like a sovereign debt
default), the global outlook is slightly weaker than projected in
October”. In other words, the global economic momentum arrow is pointing
down across the board.
Variable-rate discounts are available in the prime minus
0.40-per-cent range (which works out to 2.60 per cent using today’s
prime rate). While five-year variable rates only offer a small saving
over their equivalent five-year fixed rates, the BoC announcements
provided further reassurance that this saving should remain in place for
the foreseeable future.
The bottom line: I have long argued that the BoC’s warnings about
near-term higher rates would not come to fruition and the bank’s latest
revisions to its interest-rate guidance confirm this view. With that
question now put to rest I don’t think it’s crazy to wonder whether the
next move in the overnight rate, when it eventually does come, has as
much chance being a decrease as an increase. (And that’s especially true
if the BoC’s latest international GDP growth forecasts are on the
money.)
David
Larock MBA, AMP, PFPC, CSC is a Toronto-based independent mortgage
planner and long-time industry insider who specializes in helping
clients purchase, refinance or renew their mortgages. He is an active
blogger on mortgage related topics and his posts have been distributed
in national media and by Realtors and financial planners.