Just as the global outlook brightens, Canadian households have gone wobbly, forcing the Bank of Canada to reassess its outlook.
The trade wars haven’t calmed enough to offset the loss of the Canada’s primary economic engine for the past decade. The result is a weaker short-term outlook that could prompt the central bank to cut interest rates if current conditions persist.
But not yet.
Governor Stephen Poloz and his deputies left the Bank of Canada’s benchmark interest rate unchanged at 1.75 per cent on Jan. 22, even as they dropped their outlook for near-term economic growth.
Policy-makers slashed their growth forecast for the fourth quarter to 0.3 per cent from 1.3 per cent, and predicted that growth in 2020 will fall short of the economy’s non-inflationary speed limit, which was revised higher to two per cent.
The lone bright spot at the moment is housing, which the central bank described as “robust.” Otherwise, business investment “appears to have weakened after a strong third quarter” and hiring “has slowed.” The central bank said indicators of consumer confidence and spending “have been unexpectedly soft,” a puzzle given the tight labour markets in most regions and evidence that wages are rising considerably faster than inflation.
“Data for Canada indicate that growth in the near term will be weaker,” officials said in a new policy statement. The slump could “signal that global economic conditions have been affecting Canada’s economy to a greater extent than was predicted,” the statement said. “Moreover, during the past year Canadians have been saving a larger share for their incomes, which could signal increased consumer caution.”
The possibility that debt would eventually weigh on spending has been part of Poloz’s story from the beginning of his tenure almost seven years ago. Households took advantage of ultra-low interest rates and piled up debt after the financial crisis, just as central bankers hoped they would. But they were never expected to carry the economy for a decade. Eventually, the burden of all that debt would force consumers to tap out. Exports and business investment would have to take over.
The shift never really happened. The collapse of oil prices in 2014 and 2015 forced the Bank of Canada to keep interest rates low, and then the trade wars interrupted Poloz’s attempt to get rates back to a more normal setting. Strong hiring, outside of Alberta, and high immigration levels kept consumption going, but there was always a risk that this dynamic would lose its force.
Nothing in the central bank’s latest round of communications suggest the economy is in serious trouble. Rather, the message is simply that there probably isn’t as much momentum as previously thought. Policy-makers last year said they would be watching for evidence that the trade wars were spreading beyond corporate decision making. Now, they said, they could be seeing some.
Ahead of the latest policy decision, investors were putting extremely low odds on an interest-rate cut this year. Policy-makers are probably still leaning against a change, but the outlook is no longer so obvious.
If the headlines around trade continue to improve, consumer confidence could get better and spending along with it. Exports and business investment should slowly strengthen, which could forestall the need for stimulus. The Bank of Canada remains concerned about re-igniting a borrowing binge.
Ultimately, the central bank cares most about inflation, and weaker growth could bring deflationary pressure. “In determining the future path of the bank’s policy interest rate, Governing Council will be watching closely to see if the recent slowdown in growth is more persistent that forecast,” the statement said.