As expected, the Bank of Canada refrained from cutting interest rates at today’s policy meeting. The recent economic news has shown a marked improvement, precluding the Bank from following on the previous two rate cuts this year. The key policy overnight rate is only 50 basis points (one-half of one percentage points) and another 25 basis point (bp) cut would only reduce the Bank’s ability to take action, if needed, in the future.
The slowdown in the Canadian economy in the first half of this year had nothing to do with interest rates and had everything to do with the massive decline in oil prices. As the Bank has noted, “financial conditions are accommodative and provide considerable support to economic activity”.
In addition, a 25 bp rate cut would only translate into a 12-to-15 bp cut in mortgage and other consumer and business borrowing rates, as we have seen with the January and July cuts. The reason is the cost of funds for the lenders has risen relative to risk-free government five-year bond yields–normally linked to mortgage rates–as investors risk appetites have declined. This rise in so-called credit spreads reduces the stimulative effect of any rate cut by the Bank of Canada.
Moreover, the interest-sensitive sectors of the Canadian economy–housing, autos and other durable goods purchases–are already booming. Business investment has declined sharply, but only in the oil patch, which would not be reversed by lower interest rates. Another rate cut would only encourage increased household indebtedness and, at the margin, make little difference.
The good news is that the U.S. economy has rebounded sharply from the first quarter slowdown, with second quarter growth of 3.7 percent surprising on the high side. This has helped to boost Canadian exports, particularly for autos and aircraft. As the Bank expected, the weaker Canadian dollar has spurred the demand for Canadian products in the U.S. and elsewhere.
To be sure, the Chinese economy has slowed, putting downward pressure on certain commodity prices important to Canada’s exports, but the pick up in the U.S. has finally provided a meaningful offset.
The Bank of Canada is at last seeing the stimulative effects of its earlier rate cuts and is confident that the five-month decline in economic activity has halted with the stronger-than-expected 0.5 percent growth in June. The increase in June was broad-based. Also, more recent data show a strong uptick in employment growth. Third quarter GDP growth is in train to meet or exceed the Bank’s forecast of 2.5 percent, a welcome reversal of the first-half slide.
While core inflation has been about 2 percent, the Bank judges that the underlying trend in inflation remains at about 1.5 to 1.7 percent.
To be sure, the heightened volatility in financial markets, the slowdown in emerging economies and the potential further decline in oil prices will keep the Bank ever watchful. If the rebound in economic activity peters out later this year, which I doubt, the Bank will act quickly to cut rates once again. The next policy announcement date is October 21, just two days after the Federal election.
Orig article from Dr Sherry Cooper at: https://dominionlending.ca/news/no-surprises-from-the-bank-of-canada/
Bank of Canada kept interest rates unchanged Wednesday, in line with economist expectations. Sherry Cooper, Chief Economist, Dominion Lending Centres says although Canada’s economy is currently a mixed bag, there are some signs that it is on its way to gradual growth.