When the Bank of Canada raised its rate target by 25 basis points in September, the second such increase in less than three months, it faced some criticism on the basis that it had failed to signal its intentions to the market. This was somewhat unfair, since in fact the market was pricing in a better-than-evens chance of a rate hike by the time decision day rolled around. It was the consensus among analysts that called it wrong. Still, given Governor Poloz's proclivity for crossing up the market in the early months of his tenure -- something he has since corrected -- there were some grounds for concern over the Bank's communications strategy.
A major speech by Gov. Poloz this week in St John's seems to have convinced both markets and analysts that there will be no further rate move when the Bank's Governing Council meets on October 25. The speech is worth reading for the insights it provides into the concept of "data dependence" in decision making. Data are always about the past, and the Bank needs to form policy based on where the economy is going rather than where it has just been. Thus the Bank augments its use of formal economic models with soft data and judgment in order to reach a view on where monetary policy needs to be set.
This approach allowed the Bank to start toughening up its rhetoric earlier this year, once it perceived that the economy was on track to reach full capacity by year end. When the GDP growth rate exceeded expectations in the first half of the year, the stage was set for the rate increases that were duly delivered in July and September. However, as Gov. Poloz emphasized in St John's, the Bank is aware that both positive and negative shocks may lie in the future, so it is not predetermined that the path of interest rates will move steadily higher.
Some of the recent economic data point to the need for caution on the Bank's part. Most notably, real GDP stalled in July after eight months of steady gains. Weakness in goods production, including manufacturing, may suggest that the recent strength in the exchange rate is beginning to have an impact, a possibility alluded to by Gov. Poloz in his speech. The Bank will also want to judge whether the recent sharp slowdown in the housing market, notably in the Toronto region, may be starting to affect consumer confidence and hence household spending.
Longer-term factors may also be turning more negative. Gov. Poloz delicately referred to rising trade protectionism "in some parts of the world", but just a day before he spoke there was a sharp reminder of just which part of the world Canada needs to be concerned about. The startling US judgment against Bombardier Inc.'s aircraft division, proposing a 220 percent tariff on the company's jets, seems to have been heavily influenced by the Trump administration: the complainant, Boeing, had sought a tariff of "only" 80 percent.
The Bombardier decision comes amid increasing signs that the NAFTA renegotiations are not going smoothly, with the US making demands that are either unreasonable (e.g. on Buy America rules) or vague (e.g. on domestic content rules for vehicles). It is quite likely that the talks will not conclude by year end, and very possible that a deal will not be reached at all, prompting Trump to pull the US out of the existing agreement.
All in all, plenty of reason for the Bank to take a cautious approach going forward, beginning with no move on October 25.
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