Canada's Uncertain Economy: A Q & A

The Bank of Canada moved its interest rate up to one per cent this week. Two economists weigh in on what this tells us about the state of the Canadian economy.

The Bank of Canada moved its interest rate up 25 points to one per cent Wednesday morning. To two economists the modest jump is a signal that uncertainty still dominates the Canadian economy. The Mark spoke with Steve Ambler of the University of Quebec at Montreal and Gregor Smith of Queen’s University about the news.

The Mark (TM): What does the Bank of Canada’s announcement tell you about the state of the Canadian economy?

Steve Ambler (SA): “They’re hedging their bets quite a bit. Economic performance has been less stellar than projected in the last monetary policy report, and there’s a lot of uncertainty all over the board. So it looks like they’re preparing the market to hold steady for a while at one per cent (interest).”

Gregor Smith (GS): “I think the fact that it’s a small change reflects the fact that the signals are mixed about the state of the economy. Canadian GDP growth has slowed down over the course of this year and the U.S. indicators are also somewhat mixed. So it may be a slightly slower and more gradual recovery than is usual from a recession.”

TM: What position are Mark Carney and the Bank of Canada in as they head toward another interest rate decision on October 19?

SA: “People had been, at least based on projections in the monetary policy report and so forth, projecting the Bank of Canada to be on a cycle of increasing rates by say 25 basis points per announcement for the next little while. That was on the basis of the recovery having looked stronger than it now looks. In other words they were getting ready to fight inflation, but inflation is looking like less of a potential problem, and the robustness of the economy is looking like more of a potential problem, especially given what’s happening in the United States and in Europe.”

TM: So the small interest rate climb will likely stall out?

SA: That would be my personal prediction, yes. My prediction is that they’ll be at one per cent at the next announcement and still be at one per cent probably at year end. Unless we start getting incredibly good news out of Europe and the States.

TM: What will the Bank of Canada be considering in the lead-up to October?

GS: There’s still quite a bit of data to be revealed between now and then (August’s Consumer Price Index, for example). They have positioned themselves so they can pause without shocking markets, but I would think many commentators might still be predicting another step up.

TM: What do you think about the position the bank is in?

GS: “They’re in a very unusual situation here where they signal things and influence the economy both with the level of interest rates, and the rate of change. So here we are talking about how the economy isn’t growing as quickly as people thought it would and so interest rate increases might not occur in October and yet the level of the interest rate is still extraordinarily low. The bank has said this in its own documents. One per cent is a low number for the target overnight interest rate, so they’re in a strange position where the overall stance is still very simulative for monetary policy.

They want to make sure they don’t ignite some kind of bubble as a result of that. And yet, the conditions they’d normally look for in order to raise interest rates significantly don’t seem to be there. For example, there’s not much sign of strong inflation.”

TM: Will this have any effect on the Canadian housing market, which has already started to slow?

SA: “I think in some of the hotter housing markets it’s going to continue to cool off, but I don’t think that this particular rate announcement is going to have an impact, especially given the fact that they seem to be talking about holding steady at one per cent.

Given that the bank had started on a cycle of raising rates and now they seem to be holding off that could even encourage people who are thinking about the timing of buying a house to buy now instead of later.”

TM: What’s dragging the interest rate down?

GS: “How strong growth will be in our major trading partners is the leading one. The U.S. has big debt overhang, and it’s uncertain whether it will grow as quickly as it normally would at this stage in the business cycle. Japan is not growing quickly. There have been some very promising signs from Germany but Europe, as a whole, is not growing quickly. If these regions did start to grow more quickly that would give a boost to Canadian exports, which would presumably lead to some price pressures in Canada, but there aren’t many signs of that at the moment.”