Rush to judgement

Well, that didn't take long.  Barely two weeks after the Bank of Canada ended five years of ultra-low interest rates by venturing a 25 basis point increase in its target rate,  anonymous officials in Ottawa are apparently fretting via Bloomberg that the Bank's actions could trigger a slowdown in the economy.

Can this possibly be a reasonable fear?  After all, the Bank's new target rate is only 0.75 per cent, and even if it follows through with another rate hike this year, as seems likely, that would still leave the rate negative in real terms -- and way below levels that were considered normal and manageable before the financial crisis hit.  Most business economists interviewed by the media have dismissed the concerns of the unnamed bureaucrats, preferring to believe that the economy is in good shape to withstand not just another rate hike this fall, but also a couple more small upward moves during 2018.

I'm with the business economists on this one, but the truth is, nobody really knows, because we've never been here before.  Ultra low interest rates and large-scale printing of money have never been tried before by any responsible central bank.  Nobody envisaged that the QE-plus-free-money era would last the better part of a decade, engendering a belief on the part of many people that borrowing was essentially free and riskless.  The elevated level of household debt in Canada is apparently a key factor underlying the concerns in Ottawa.

Thoughtful commentators warned years ago that stopping monetary stimulus would be a lot harder than starting it. The caution being shown by the Federal Reserve in raising rates and tapering QE clearly shows that central bankers are aware that they are flying without a compass here. Despite his more hawkish rhetoric in advance of the recent rate hike, it's apparent that Bank of Canada Governor Stephen Poloz is also minded to proceed with extreme caution, ready to reverse course if the economy reacts badly to gradual policy tightening.

As it happens, economic data released today clearly show why the Bank saw the need to start raising rates this month.  Canada's GDP rose 0.6 per cent in May, far ahead of expectations.  It now stands 4.6 percent above its year-earlier level, the strongest such gain since 2000.  The Bank's expectation that the economy will reach effective full-capacity by the end of this year seems certain to be met. The strength in the exchange rate -- up 10 percent in the last two months -- will have to factor into the Bank's thinking at some point, but there is no reason to second-guess the recent change in its policy stance.