It was reported on Tuesday that Canada's GDP shrank marginally in April, the fourth decline in a row. Although the energy and resources sector was predictably the worst performer, the weakness was surprisingly widespread across major sectors of the economy. As a result, market expectations of another Bank of Canada rate cut, perhaps as early as this month, have solidified.
It seems unlikely that Bank Governor Stephen Poloz will resist the temptation to ease further. Speaking at a BIS meeting last weekend, Poloz compared the Bank's surprise rate cut in January to life-saving surgery, and dismissed the possible impact on Canadian households' record indebtedness as mere side effects: "If the doctor says you need surgery to avoid death, the side effects don't usually deter you, you just go ahead and manage them somehow". A new definition of manage, it would appear: ignore them, and hope they go away, because there's no sign that the Bank is doing anything at all about debt levels.
If we want to stay with Poloz's medical analogy, it might be appropriate to ask if the medicine is actually working. Interest rates have been at record lows for half a decade, the exchange rate has depreciated by 25 percent in the last three years, the all-important US economy is moving smartly ahead -- and Canada's non-oil economy continues to struggle for traction.
It ought to be clear by now that the economy's malaise is structural, the result of the hollowing out of the manufacturing sector as a result of a series of free trade deals and the emergence of lower-cost competitors around the world. Many of the parts of the economy that would in the past have offset the weakness in the energy sector simply don't exist any more. With the Bank's reference rate already down to 0.75%, any further cut that Gov Poloz may decide upon amounts to no more than an empty gesture, one that's highly unlikely to have any impact on the economy's underlying strength.
It will, however, have an impact on indebtedness. Cheap money will continue to drive housing prices, especially in Vancouver and Toronto, to fresh records, and to push the household debt/income ratio to unsustainable highs. It's being reported that the same US investors who bet against the US housing market almost a decade ago (see Michael Lewis's The Big Short for a knockabout history of the time) are now setting themselves up to profit from what they see as an inevitable bursting of the Canadian housing bubble.
The economy will very likely start to do better in the coming months, whether the Bank cuts rates again or not; but any gains are likely to be swamped by the huge losses that will quickly be felt when the bubble bursts. We won't be calling them side effects when that happens.
And on that cheery note, happy Canada Day, Governor Poloz!
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