Bank of Canada approaches uncharted territory today with Canada’s recovery in tatters

Stephen Poloz is within a no-win situation.

Bank of Canada warned rate cut will fan flames of loonie’s ‘unprecedented’ free fall

The Canadian dollar is falling too much and too fast, damaging public and business confidence in Canada, say economists. Read on

As the financial institution of Canada governor prepares to produce his rate of interest decision, forecasters are about evenly split on whether he’ll cut the benchmark rate to 0.25 per cent or let it rest at 0.5 per cent. A cut risks contributing to a previously epic currency slump and could do little for growth; standing pat gives the impression the central bank is cold towards the widening damage from collapsing oil prices.

As if that wasn’t enough, extraordinary policy tools for example negative minute rates are now on the table the very first time in the central bank’s 80-year history. Poloz is approaching uncharted territory, and the stakes are high: there’s speculation the economy, that is still convalescing after two quarters of contraction in the first 1 / 2 of 2015, is at another tipping point.

“It’s not going to take a lot to shock the system and push us right into a recession,” said John Johnston, chief strategist at investment manager Davis Rea Ltd. in Toronto. “The financial institution of Canada will cut rates, it’s a no-brainer. If he doesn’t he’ll get crucified.”

Others say lower rates won’t accomplish much, and it’s time for you to allow the economy adjust.

“Why would Poloz do another rate cut? In my experience that doesn’t make sense at all,” Martin Pelletier, managing director and portfolio manager at TriVest Wealth Counsel in Calgary, said inside a Jan. 15 phone interview. “The dollar has fallen below 70 U.S. cents therefore it should be doing its magic. Why do you need to lower rates?”

The loonie has depreciated 17 per cent from the U.S. dollar over 12 months, tracking the price of U.S. benchmark crude which has plunged to below $30 a barrel. Policy divergence – the Federal Reserve is raising rates of interest, and chances are Poloz will cut at least once this year – is adding momentum to the currency’s decline. An interest rate reduction now would drop the financial institution of Canada’s benchmark rate underneath the Fed’s for the first time since 2007.

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There’s a disagreement to be made that Poloz has done enough, having already lowered the benchmark rate twice last year, in January and July, and now it’s the government’s use increase spending. Prime Minister Justin Trudeau’s debut finances are due by April. Trudeau has already backed off an offer pledge to cap deficit spending at C$10 billion annually. Former Bank of Canada Governor David Dodge recommends federal and provincial governments run combined deficits of as much as $40 billion a year.

All of this would take time, something the economy might be not having enough.



In its last monetary report, the central bank predicted Canada will go back to full capacity with inflation in the 2 percent target through the middle of next year. It also projected GDP growth of 2 percent this season. However with the oil shock still reverberating, and also the advantages of a currency at 69 U.S. cents slow to accrue, that forecast is looking increasingly doubtful.

Poloz’s decision is due at 10 a.m. from Ottawa. Whatever he does, he must be clear about whether extraordinary measures such as negative rates or quantitative easing are closer to being a reality, Johnston says. The financial system could withstand rates as little as negative 0.5 percent, the governor said in a Dec. 8 speech that outlined the bank’s options as it approaches the so-called lower bound. Those measures aren’t required now, he explained at that time.

“I’ll be more interested to see if the Monetary Policy Report itself talks more about the monetary strategy moving forward,” Johnston said. “Within an anxious environment like this the financial institution of Canada is going to want to be seen to do something.”

Investors are now assigning 51 per cent odds Poloz will cut the overnight rate, up from 13 percent a month ago. Three of Canada’s biggest lenders changed their forecast to a cut a week ago, bringing the entire in a Bloomberg survey to 16 out of 34 economists predicting lower rates.

For Johnston at Davis Rea and many more, it’s the rate of the bad news that makes more stimulus necessary.

“Last month I would have said there really isn’t any big reason to chop rates,” Johnston said. “It’s clear, he should do something, to appear to do something, and to be showing that they care.”

Bloomberg.com