Bank of Canada could still raise rates - just not right now

Governor Stephen Poloz’s comments had a definite “doveish tinge”, though economists expect a rate hike in the second half of this year

Ruth Saldanha 22 February, 2019 | 6:00PM
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In a mostly expected move, the Bank of Canada indicated that though it will eventually need to raise rates up to the neutral zone, however the pace and path to that zone is uncertain.

“We judge that we will need to move our policy rate up into a neutral range over time, to a point where it is not stimulating or constraining economic growth. However, the path back to that neutral range is highly uncertain,” said Bank of Canada Governor Stephen Poloz.

The ‘doveish’ tone the governor used has changed from an extremely ‘hawkish’ one last year. The change stems from two major risks – the high levels of household debt, and the outlook for business.

Poloz pointed out that given the highly elevated levels of debt, raising rates will have more of an impact on the overall economy than in the past. He also noted that housing activity has been a little weaker than expected recently, as housing markets adjust not only to higher interest rates, but also to new mortgage guidelines and rules cooling certain housing markets.

The second area of interest he indicated was the outlook for business investment, which has been less robust for the past couple of years, mainly due to uncertainty about the future of the North American Free Trade Agreement.

“Although uncertainty remains around ratification of the new Canada-United States-Mexico Agreement, we expect investment spending to regain momentum in 2019, especially in light of the government’s new accelerated capital depreciation rules. However, we must acknowledge that the future of the global trade environment is highly uncertain right now. An escalation of the US-led trade war would, of course, be a negative for the outlook, but a resolution would be a source of new lift for the global and Canadian economies,” Poloz said.

“The Governor’s statements show a measure of caution that was not apparent before. Though the messaging was consistent – that rates need to rise – there was a doveish tinge to his statements,” said Royce Mendes, senior economist at CIBC, who noted that Poloz did not stick his neck out to commit to a timeline.

Mendez points out that despite this, the Bank of Canada is likely to raise rates, though it is becoming difficult to see how it will rise to a mid-neutral level of 3%.

The Bank of Canada estimates the neutral range at between 2.5% to 3.5%. At present the benchmark interest rate is 1.75%.

“The key theme here is uncertainty and the fact that it has risen and likely won’t fade away for a while,” said BMO Capital Markets Senior Economist Sal Guatieri in a report, pointing to the highly uncertain outlook for the rate path stemming from highly uncertain trade policies (including ratification of the USMCA), a somewhat weaker-than-expected housing market, and uncertainty about the investment outlook mentioned by the governor.

Gautieri expects just one more rate hike this cycle, but not until December.

Mendes agrees and also expects a rate hike, but in the second half of this year. “In the first half of 2019, we will see subdued growth on the back of the reduced oil production. It will be tough for the Bank to raise rates in the immediate term. However, in the second half, we will see growth increase on a rebound in oil production, so it is likely we will see a hike in the second half,” Mendes said. After that hike, future hikes will depend on economic trends, he said.

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Ruth Saldanha

Ruth Saldanha  is Senior Editor at Follow her on Twitter @KarishmaRuth.


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