Business·Analysis

Bank of Canada's enviable problems include sunken loonie and threat of inflation: Don Pittis

Other central bankers just wish they had Stephen Poloz's problems. Signs of growth and a tightening labour market mean inflation might be around the corner. Don Pittis says the Bank of Canada's biggest worry is how to hang on to its advantages.

Suddenly a low loonie, falling commodity prices and an inflation threat don't seem so bad

These kinds of problems may have Bank of Canada Governor Stephen Poloz smiling when he meets with the media this week, especially since his predictions for an uptick in the Canadian economy have come true with a vengence. (Reuters)

In an upside-down world it suddenly seems as if Canada's problems have become advantages.

The country's commodities economy has been hit hard by crashing prices. Its currency has been plunging. Now a tightening job market and surging GDP seem to signal that inflation could be around the corner.

In another era those would have seemed like nothing but headaches for Bank of Canada governor Stephen Poloz, but as he makes his monetary policy statement on Wednesday, other central bankers only wish they had his problems.

Just four months ago Stephen Poloz surprised the world by saying the Bank of Canada was contemplating negative interest rates. As that experiment turns sour elsewhere, Poloz must be positively thrilled the plan never got off the drawing board.

The loonie advantage

And the reason Poloz didn't have to break out that untried secret weapon has a lot to do with characteristics of the Canadian economy that would in other times have been considered deficiencies.
During the oil and commodities boom, the rising loonie crushed many weak Canadian companies, something that has yet to happen in other economies. (Reuters)

Being a medium-sized resource-dependent country without access to one of the world's great currency blocs once seemed a problem. For parts of the economy it definitely was.

As it's not part of a bigger currency bloc, the loonie is easily pushed up and down by trade flows. But now, rather than being trapped in a currency bloc with money that is inappropriately valued, as are Eurozone members Greece and Finland, Canada is feeling the benefits of something that once seemed like a curse.

Economy-eating disease

One of the great retrospective triumphs of outgoing New Democratic Party leader Thomas Mulcair was his identification of Dutch disease as eating away at Canada's non-resource economy. The problem was that identifying it did not mean there was anything anyone could do about it.

As foreign currency flooded into Canada to buy our resources it first had to be converted into Canadian dollars, pushing the loonie above the value of the U.S. greenback.

Now, while everyone else in the world tries to manipulate their currencies to drive them down, crashing resource prices have already done the job for the loonie. The Bank of Canada didn't have to lift a finger. 

While Canada's oilsands are suffering due to the low world price for oil, employment statistics show that non-resource portions of the Alberta economy may be benefiting from the lower Canadian dollar. (Reuters)

This week's G20 meeting is expected to include a scolding for countries who have tried to beggar their neighbours by cutting interest rates and making their exports cheaper. Canada's Poloz is beyond reproach because reverse Dutch disease has done the job for him.

Fewer Zombies

For the same reason Canada has fewer zombie companies kept alive by artificially low interest rates. Canada's weakest non-resource operations were clubbed into submission years ago by the high loonie. 

And while so much of the rest of the world suffers from the ugly and dangerous effects of deflation, new signs of a Canadian economic rebound and renewed labour demand may actually hint that inflation could be on the way.

At this week's meeting of the International Monetary Fund, held in conjunction with the G20 in Washington, Poloz and Finance Minister Bill Morneau should each earn a gold star from IMF chief Christine Lagarde. She likes stimulus and inflation and she wants to see more of it.

The knock-down drag-out fight between those who favour and those who oppose the negative interest rates strategy will continue at the meeting. But there are a growing number of voices who worry it is dangerous and destabilizing to the world economy. Like quantitative easing before it, negative rates are showing no clear signs of having helped the broader economy.
Extreme measures from quatitative easing to negative interest rates are doing little to help the Japanese economy that is still suffering from deflation and a rising yen. (Reuters)

Early indications from Japan are that it has not had the expected effect of making the currency more competitive. Demonstrating how little these economic tinkerers understand what they are doing, negative rates have unexpectedly driven the yen and the euro higher

So how does this affect what Poloz will tell us on Wednesday?

Inflation bullseye

As everyone has said so far, despite strong growth and jobs and the prospect of federal government stimulus spending, there are no expectations that the Bank of Canada will change interest rates this time round.

In the longer term, however, Poloz, so long focused on interest rate cuts, may find himself contemplating a rate increase. If inflation rises much above two per cent, under current Bank of Canada rules his hands will be tied.

As the bank has said in the past, the inflation target could be adjusted up a touch, or, for example, made discretionary up to say, four per cent. While such a move would not force the consumer price index to rise, it could have a psychological effect, increasing inflation expections for both prices and wages.. 

Such a decision could only be made after agreement by the federal government. But at tomorrow's meeting watch for a firm statement ruling out a change in the inflation target, or a sign that the door has been left open a crack.

Follow Don on Twitter @don_pittis

​More analysis by Don Pittis

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.