When the Bank of Canada talks rates, analysts hang off of every word. They pay special attention to biases in the Bank’s wording (i.e., which way the Bank is leaning on interest rates).
The media loves to pump commentators for predictions on whether the BoC will keep its rate “bias,” not keep its bias, do something unexpected with its rate bias, and on and on. It’s quite the drama over what is usually a 1-3 sentence statement in a BoC press release.
For one thing, the Bank’s statements have to be interpreted correctly. Most of the time, they’re so vague that they offer minimal predictive value (the quote above is case in point).
Then, there’s the small matter of accuracy. The BoC sets its key rate based on where it sees inflation 18-24 months down the road. But most of the time (especially these days) there is virtually no data that gives the Bank of Canada clarity on inflation two years ahead.
Indeed, despite employing the best data/technology and some of the top analysts in the country, the BoC (like most economists) has tended to be over-optimistic with longer-term forecasts.
And then there’s the question of how long a rate cycle will last. It’s great to know that the BoC may hike rates next quarter, for example, but how long will rates stay elevated? When will they revert lower again?
In most cases, these factors make it hard to read too much into the BoC’s rate guidance—especially since its biases can change without notice (due to unforeseen events or crises).
But initial rate hikes, as telegraphed by BoC guidance, are just that. They don’t portend what comes next.
When it finally does lift rates, the Bank expects those hikes to be “modest.” And why shouldn’t they be? High inflation (the killer of low rates) is an enemy of the state. The government would allocate all available resources to eradicate it.
It’s also worth noting:
When core CPI inflation approaches 3%, it becomes a problem. But the BoC’s mandate is to set rates that achieve neutral 2% inflation. And it does a bang-up job of that. In fact, inflation has averaged close to 2% for 20+ years now.
The odds of explosive (inflation-inducing) growth are small in Canada’s mature economy. Major analysts (example1; example2) expect long-term GDP growth to wallow near 2% annually. But two per cent growth does not, in any way, support materially higher rates long term.
Assuming the BoC’s mandate stays the same, the structural changes* in Canada’s economy seem to imply a high probability of historically low output. And if growth isn’t robust enough to trigger inflation, rates could stay under long-term averages for years. (That’s not to say they won’t spring higher for short periods.)
(* Structural changes include but are not limited to an eroding manufacturing base, free trade, the economy’s oil dependence, U.S. energy independence initiatives, savings/investment trends, a smaller housing contribution to GDP, and the employment drain due to global outsourcing and technology.)
Types of Guidance
The BoC has no problem being cryptic. That’s partly intentional and partly reflective of future uncertainty.
So when you see strong guidance, make note. It often tips the BoC’s hand.
“With recent improvements in the economic outlook, the need for such extraordinary policy is now passing, and it is appropriate to begin to lessen the degree of monetary stimulus.”
That was the BoC’s statement right before it began raising rates in 2010.
Here’s another example:
“…Some reduction in the amount of monetary stimulus will be required in the near term to keep aggregate demand and supply in balance and inflation on target.”
Note the words “near term.” This was the BoC’s statement right before it started its 2005 rate hike cycle.
We’ll close off with two key points here, and they are this. Generally speaking, until Canada posts at least 2-3 consecutive months of all-around promising economic data, BoC rate hike biases carry less weight.
On the other hand, as the Bank’s statements become more definitive (e.g., with specific near-term timeframes for adjusting rates), they tend to mean business. In those limited cases, one can often expect imminent rate changes.
“Both total and core inflation are expected to remain subdued in coming quarters before gradually rising to 2 per cent by mid-2015 as the economy returns to full capacity.”
“With continued slack in the Canadian economy, the muted outlook for inflation, and the constructive evolution of imbalances in the household sector, the considerable monetary policy stimulus currently in place will likely remain appropriate for a period of time, after which some modest withdrawal will likely be required.”
The next interest rate meeting is July 17. With Mark Carney off to Britain, Canada’s brand new central banker, Stephen Poloz, grabs the reins.
Rob McLister, CMT
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