Analysis

Interest rate cuts a two-edged sword for Bank of Canada: Don Pittis

Will Bank of Canada governor Stephen Poloz cut interest rates? It might give the economy another boost but it would also announce things are much worse than the government has been saying.

Another decrease could spur exports but would announce serious pessimism

Prime Minister Stephen Harper announced last week that he had consulted with Bank of Canada governor Stephen Poloz on the economy, which seems no closer to sustained recovery than when Harper appointed him. (Canadian Press)

Conjure up an image of Bank of Canada governor Stephen Poloz in Hamlet pantaloons, hand to brow, declaiming to the middle distance: "To cut or not to cut?"

A confusion of contradictory economic data means it may be a melancholy choice. If the Bank of Canada were to lower interest rates for a third time this year at this Wednesday's meeting, the cut could spur exports and challenge other countries that have pushed their currencies lower.

But there is a danger that it may instead be taken as a warning.

A poll of 40 economists last week by Reuters didn't rule out another cut in rates. The consensus was that there was a one in four chance of a cut this week, and a 40 per cent chance of another cut "at some point." But the most likely result, said the economists, was a rate freeze till 2017.

Frozen

More than a year of rates frozen at 0.5 per cent is not a resounding vote of confidence in a Canadian recovery. But in the face of that steady-as-she-goes opinion from economists, another rate cut would be a two-edged sword.
Cutting interest rates would help keep the Canadian property market strong. (Darren Calabrese/Canadian Press)
 

Lower rates would make it easier for Canadians to keep up their borrowing binge, helping retail sales and keeping house prices strong. More usefully, it would help secure lending for struggling or expanding businesses.

A byproduct of lower rates is a lower loonie. If, as many have said, our shrinking trade deficit can be credited to a low Canadian dollar, then a still lower loonie could be even better.

The danger is that a cut would signal that the bank, after studying all the data we have seen — and some we may not have seen — has decided that the Canadian economy is doing worse than anyone had thought. And while that too would help drive down the dollar, the hazard is that pessimism will breed greater pessimism.

Disentangling the data

Whether or not the Bank of Canada decides to cut, it will be instructive to hear the governor's disentangling of the latest economic data.

The fact is that, despite some positive thinking by my colleague Paul Haavardsrud, economic indicators are not unequivocally good or bad.

GDP was weak, though growth seemed to be seeing an uptick in June. While both U.S. and Canadian trade deficits fell, U.S. factory activity hit a two-year low. And jobs figures, though hardly gloomy, were not entirely reassuring.

Improbably, Saskatchewan led the way in job creation, adding some 4,000 positions. All those jobs just happened to coincide with a deficit the province blamed on the worst forest fire season in years.

Firefighter jobs and all that deficit spending (the province had projected a $107 million surplus) cannot be counted on to continue once the snow flies and the provincial government retunes its balance sheet. Alberta and British Columbia got a similar dollop of one-time spending from their fires.
Canadian automotive exports exceed energy for the first time since 2007. Canada is no longer a petro-economy. (CBC)

In the industrial heartland of Ontario and Quebec, which was supposed to benefit from a lower dollar and a U.S. economic takeoff, jobs were stagnant. 

Petro-economy no longer

That despite the fact that according to the latest trade figures Canada is no longer a petro-economy, as automotive exports exceeded energy exports for the first time since 2007.

Neither did new jobs across the country show a big business rebound, with public service jobs representing the lion's share of new positions.

When Stephen Harper appointed Poloz in 2013, many of us thought his toughest job would be raising interest rates as the global economy strengthened. Now that recovery seems no closer. 

In a 2014 speech, Poloz referred to Canada's housing sector as a "cracked tree," secure so long as nothing disturbs it.

As stock markets hit new lows last week, with the U.S. central bank contemplating an interest rate rise at its next meeting and the world's developing economies facing new trials, it feels like autumn turbulence could still knock the Canadian economy awry.

To return to Hamlet, "When sorrows come, they come not single spies, but in battalions."

Of course Canada's future is far less gloomy than that of Shakespeare's play, which does not end well. At least for Hamlet.

Canada's petro-economy may be fading. Its industrial economy is unlikely to return it its old form. But Canada has new opportunities, for example in technology, services and education.

Perhaps Poloz will be able to take comfort in this slightly fractured Hamlet quote: "There are more things in heaven and earth than are dreamt of in your economics."

About the Author

Don Pittis

Business columnist

Don Pittis was a forest firefighter and a ranger in Canada's High Arctic islands. After moving into journalism, he was principal business reporter for Radio Television Hong Kong before the handover to China. He has produced and reported for the CBC in Saskatchewan and Toronto and the BBC in London. He is currently senior producer at CBC's business unit.

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