Governor Poloz sounds like he means it

In mid-June, Bank of Canada Governor Stephen Poloz stunned markets by hinting that the Bank might soon consider raising interest rates, given the unexpected strength of the Canadian economy.  This week, speaking in Portugal (at the same ECB conference as Bank of England boss Mark Carney), Poloz delivered the same message.  Analysts and traders now consider that a rate hike at the Bank's July 12 policy meeting is a real possibility.

Poloz's phrasing is crucial here.  Both in mid-June and again this week, he asserted that the Bank's low rates "have done their job".  Not "are doing their job", which would imply that the policy was set to continue for the time being.  The use of the past tense seems like a strong hint that the need for so much monetary stimulus has passed.

If you look at the growth picture, you can see why the Bank might think this.  The economy grew better than 3 percent in the first quarter of the year, the fastest rate in the developed world, indicating that the process of adjustment to low global energy prices is over.  While the Bank does not expect the first quarter's pace to be sustained, it notes that the global growth environment continues to improve, providing support for further gains in Canada.

One key element in the Bank's thinking is surely the fact that the balance between monetary and fiscal policy has shifted in the two years since the Trudeau government took office.  After the 2015 election, Poloz all but begged the new government to take on more of the job of keeping the economy afloat.  Trudeau and his team have delivered in spades: the modest and temporary fiscal stimulus promised during the campaign has turned into something much larger and more long-term.  Now that the economy is growing much faster than its long-term potential rate, which the Bank thinks is close to 1.5 percent per annum, removal of monetary stimulus seems an obvious step.

All of that said, there are reasons for caution.  Headline inflation, at 1.3 percent, is well below the Bank's 2 percent target, and seems likely to stay that way for the foreseeable future.  Wage gains remain modest, despite the steady growth in employment.  And last but not least, household debt remains close to an all-time high.  All reports suggesting that Canadians continue to add enthusiastically to their debt burden, with the proportion of ultra-high-debt households steadily rising.

The July 12 policy decision brings with it an updated financial policy review, which will spell out the Bank's thinking on these and other issues in greater detail.  Markets are pricing in about a 50 percent chance of a July rate hike, something that seemed inconceivable less than a month ago.  The fact that Gov. Poloz and his senior colleagues are repeating their newly hawkish message so frequently would suggest that the odds of a move may already be higher than that.