As expected, the Bank of Canada raised its interest rate target by 25 basis points to 1.75 percent today. The Bank also published its updated Monetary Policy Report. Senior Deputy Governor Carolyn Wilkins's opening statement provides a very full summary of the Bank's current thinking and the likely direction of monetary policy over the next few quarters.
The Bank considers that the economy is operating close to full capacity, and notes that the growth is broad-based. The NAFTA renegotiations, which had weighed on business investment, have been successfully completed, even if the deal has not yet been ratified by any of the three participants. This eliminates one potential impediment to continued growth, although the Bank notes that there is still uncertainty over the US-China trade relationship, which has significant implications for Canada.
In terms of inflation, the Ms Wilkins noted with evident satisfaction that the Bank's staff had been correct in their assessment earlier in the year, that the spike in headline CPI would prove transitory. Although headline CPI is still just above the Bank's target level, at 2.2 percent, the preferred core measures are all right at the target level, consistent with an economy operating at full capacity. Despite a healthy labour market and low unemployment, wage gains are well-contained at 2.3 percent year-on-year. However, the Bank sees this as a lagging indicator and expects wage pressures to move somewhat higher.
The Bank believes a "neutral" interest rate would be in a 2.5-3.5 percent range. Ms Wilkins's statement makes it clear that the Bank intends to move rates into that range. However, it is no longer describing its approach as "gradual", in order to remove any impression that there is any kind of pre-set path. Actual rate moves will be data-dependent. One factor the Bank is continuing to watch carefully is the level of household debt. This has shown some very slight moderation, but is still so high that each rate move by the Bank pushes more households toward financial stress.
One factor the Bank did not focus on today is fiscal policy. Despite the strong performance of the economy, the Federal Government continues to run significant deficits, with little improvement in prospect. This excellent piece from Bloomberg, published ahead of today's rate decision, summarizes the issue very well.
There will be a Federal election on October 21 2019, and between now and then Finance Minister Morneau will table a fiscal update (in the next few weeks) and a full budget in the spring. After the 2015 election Justin Trudeau bragged that it was his pledge to run small budget deficits, in contrast to the fiscal austerity of the previous Tory government, that won him the election.
Recall that the actual pledge was for deficits of $ 10 billion or so for just a couple of years, with a return to balance by about the time of next year's vote. Actual deficits have been near twice that size, with no path for a return to balance. These deficits are arguably unnecessary and are indisputably complicating the Bank of Canada's job, but the chances of Trudeau and Morneau changing tack with voting day approaching are just about zero.
Finally, a little hat-tip. It's unusual to find any business economist with a novel and arresting way of describing things, but Bloomberg's reporter has found one. Frances Donald of Manulife Asset Management is quoted as saying of the US and Canada that "these economies are sprinting in the middle of a marathon and that will lead to exhaustion". Well done, Ms Donald! I wish I'd said that, and at some point in the future I almost certainly will.
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