Normally, we’d preview the Bank of Canada’s next policy decision closer to the actual date. But all the relevant data has been published, so why wait? Unless the central bank scraps its story, it will leave the benchmark rate at 1.25 per cent on May 30.
Canada’s dollar dropped half a cent against its U.S. counterpart on Friday, probably because new readings on inflation and retail sales suggest the economy is chugging along, not racing ahead at a pace that would alarm policy makers. The prices of financial assets linked to short-term interest rates put odds of an interest-rate increase next week at about 25 per cent.
The sudden wobble in the renegotiation of the North American Free Trade Agreement might also have influenced traders. Policy makers have characterized uncertainty about trade policy as the biggest headwind facing the economy because it’s a chill on investment. So the shift to a protracted negotiation, after politicians spent several weeks suggesting a deal was close, is a negative.
But trade never was going to play a major role in the May decision. The vibe around NAFTA was turning positive a month ago, and the Bank of Canada opted to leave the benchmark rate unchanged. Officials said they would stop worrying about trade only when they saw evidence that business investment was holding up. RBC Capital Markets said last week that its monitoring of company announcements suggests a modest increase in spending. Still, definitive data won’t be available until after May 30: Statistics Canada will release its tally of second-quarter gross domestic product the following day, and the central bank’s quarterly Business Outlook Survey is due on June 29.
That’s why the policy announcement scheduled for July 11 is the earliest the Bank of Canada could raise interest rates and remain consistent with what it’s said about how it would react to trade news, positive or otherwise. To move in May would require a noticeable change in other economic variables and that hasn’t happened.
To be sure, oil prices are about $15 a barrel higher than central bank’s current forecast, which is based on prices a month ago.
That will prompt some debate over the next 10 days as policy makers deliberate over where the economy is headed. Normally, a shift of that magnitude would represent a material change in Canada’s prospects. Yet there has been no discernible change in the value of the currency, the TSX or the outlook for economic growth, according to economists at Bank of Montreal. Higher crude prices mean the value of exports is rising, but those gains are being offset by doubts about whether the increase will last and the future competitiveness of Canada’s high-cost oil industry.
One indicator that would outweigh concerns about business investment is inflation. The Bank of Canada’s primary mission is to keep the consumer price index advancing at an annual rate of about 2 per cent. Statistics Canada reported the CPI increased 2.2 per cent in April from a year earlier, the third-consecutive month that inflation exceeded the central bank’s target. That’s noteworthy because annual price increases had brushed the target only three times in the previous three years.
The upward pressure on inflation could make the May decision a closer call than currency traders seem to think. The Bank of Canada cares more about three specially crafted inflation gauges than it does the headline number, which is often distorted by surges and plunges in energy and prices. Two of those three measures now are above 2 per cent, and the third is at 1.9 per cent, so for the first time since early 2012 all four of the key price indicators have been at target or higher. Sebastien Lavoie, a former staffer at the BoC who now is chief economist at Laurentian Bank Securities in Montreal, calculated that prices for 24 of the items in StatCan’s CPI basket were increasing at a rate faster than 3 per cent in the first quarter, compared with 22 that did so in 2017. The number of items that were cheaper declined to 30 from 34. The change suggests inflation is heating up, if only gradually.
“We still think it is preferable for [Bank of Canada] officials to remain on the sidelines at the May 30 monetary policy decision meeting,” Lavoie said in a note to his clients. “This being said, this decision is likely to be a close call given that two of the three core inflation measures are now above the 2% target.”
The two other factors that dominate the Bank of Canada’s narrative about the economy are household debt and Poloz’s contention that lower interest rates might actually help policymakers stay ahead of inflation.
Household debt is about 100 per cent of GDP, compared to about 70 per cent in 2005, according to the International Monetary Fund’s new Global Debt Database. All that debt probably means consumers are more sensitive to changes in interest rates than they were in the past. So the BoC is looking for evidence that credit growth is slowing, but not so fast that it crushes domestic demand. And as you might expect, higher interest rates appear to be restraining consumer demand. StatsCan said last week that retail sales jumped 0.6 per cent in March from the previous month, but only because of a surge in automobile purchases. Most other retail segments are essentially unchanged from January 2017.
Sluggish retail sales support Poloz’s argument that Canada’s economy isn’t as strong as its 5.8-per-cent jobless rate suggests. He sees elevated rates of long-term and youth unemployment as marks of the financial crisis and the oil-price collapse. Higher interest rates risk killing growth that could pull more of those people into the labour market and Poloz has been crystal clear that he intends to do what he can to encourage that to happen.
“In some models of the economy, that would become a permanent thing, a hysteresis thing,” Poloz said of the elevated number of marginalized workers, while talking to me and a couple of other journalists in Washington last month. “Well, if it can happen in one direction, there is no reason with enough time that it can’t be reversed because it’s just people combined with new investment, just building more economic building blocks.”
He added: “You’ve got to believe we’re going to get a fair bit of that. But again I can’t guess how much, but I think it’s a really important phase.”
It will take some strong evidence to push Poloz off that course and there hasn’t been enough since then to force a pivot. Bottom line: low for a bit longer.