Bank of Canada Governor Mark Carney has said Canadian monetary policy cannot deviate too much from U.S. policy.Sean Kilpatrick/The Canadian Press
Amid cryptic statements from central banks, nervous investors want to know when borrowing costs will head upward. David Parkinson seeks answers in an e-mail discussion with a panel of experts
David Parkinson, The Globe And Mail : In past weeks, we've heard first from the Bank of Canada, then U.S. Federal Reserve Board boss Ben Bernanke. Have they provided any clearer view of where interest-rate policy is headed and when? Or is the lack of clarity the problem?
Douglas Porter, BMO Nesbitt Burns: I think we are quite a bit closer to understanding where interest rates are going: nowhere fast. Lack of clarity from policy makers is not a big concern for the market at this point; the issue is the so-called soft patch in U.S. and global growth.
Christopher Ragan, C.D. Howe/McGill: I think there is a lack of clarity, at least in terms of the Bank of Canada's intentions. I am troubled by what I see as an inconsistency - the target overnight rate currently at 1.0 per cent and the Bank's forecast that [gross domestic product]will return to its potential by the middle of 2012. These two facts suggest to me a need for a rate path that is pretty steep (and without pauses) over the next 12 months. Is the Bank really prepared to do this? Or does it not believe its own statements about closing the output gap by mid-2012?
Eric Lascelles, RBC Global Asset Management: Even if conditions stabilize and the recovery recommences, it seems clear that the traditional monetary policy playbook has been tossed out the window. Risk-reward considerations are playing a bigger part, asset prices are taking a more central role, and - as Chris says - there seems to be a willingness to leave stimulus on the table for far longer than traditional rules-of-thumb would advise.
Mr. Ragan: I'm okay with the idea that the economic environment, and all of the risks contained in it, may have changed the way central bankers think about their policy choices. But has this evolution of thinking been adequately explained to the public? If the likely level of the "neutral" policy rate is now much lower than we once thought, then the implication is that a policy rate of 1.0 per cent is not that low. If this is believed to be true, then perhaps it should be said.
Mr. Porter: Some officials at the bank have made it clear that they don't believe that rates necessarily have to be right back to neutral when the economy is back to full capacity (i.e., no output gap), if there are other restraints (such as a strong Canadian dollar). Moreover, with the growth outlook subsiding even since the April Monetary Policy Report, it's no longer clear the output gap will be closed by mid-2012. Based on our latest forecast, we think it will be closed by end-2012.
Mr. Ragan: If the "gap closing date" has shifted to the end of 2012, then their current path appears much more consistent. It is interesting that both Finance Canada and the PBO [parliamentary budget officer]see the output gap closing about two years later than the bank.
Mr. Lascelles: We don't really know what constitutes a neutral level for interest rates, given the prospect of a global downshift in productivity relative to the precrunch era and headwinds from fiscal austerity. It is likely lower than before, in any event. There's an old saying that central banks take the elevator down and the escalator back up; normally, rate hikes come much more gradually than the cutting. I'm increasingly of the mind that the Bank of Canada and the Federal Reserve will hold pat for much longer than normal, but could then be obliged to take the elevator back up - bigger rate hikes.
Mr. Parkinson : So what are they telling us about when policy rates are going to start to rise?
Mr. Ragan: [Bank of Canada Governor]Mark Carney has already said that he feels Canadian monetary policy cannot deviate too much (or for too long) from U.S. policy, because of the effect on the Canadian dollar. I think this was an unfortunate thing to say. If domestic conditions warrant a rise in rates, then a strengthening of the Canadian dollar is fine - it is one of the ways that monetary policy operates in an open economy with very mobile financial capital. But his statement may be a signal that we won't start rising until the U.S. does.
Mr. Lascelles: The Fed continues to insist that rates will remain at "exceptionally low levels" for an "extended period." That has to mean no sooner than early 2012, and quite possibly later. The Bank of Canada revealed a few cards last week when it said that some stimulus "will be eventually withdrawn." In the absence of a Rosetta Stone that converts words into dates, we can only guess that this might mean tightening as soon as this fall, and likely no later than early next year.
Mr. Porter: It seems to me that the Bank was clearly trying to keep the prospect of rate hikes on the table for 2011 in its latest statement. … But the use of "eventual" and the caveats added afterward suggest that they will wait at least until September before hiking rates, and they could easily wait until the October meeting if the North American economic results don't soon improve.
The Fed could easily wait until next spring.
Mr. Parkinson: So what does this mean for the financial markets?
Mr. Porter: With 10-year government bond yields now hovering around 3 per cent, and short-term markets all but pricing out any central bank tightening any time soon, it seems that financial markets are assuming a further extended period of bargain-basement policy rates. Financial markets will now be focused laser-like on the strength of the global recovery, and specifically the U.S. economy. If the current soft patch turns more ominous, a repeat of last year's spring/summer correction for stocks and commodities could be in the cards, taking the Canadian dollar down for a spell. Our view is that a spate of temporary factors depressed activity in the spring, and growth will revive in the second half, at least partially.
Mr. Lascelles: In theory, low rates for longer should allow financial markets to continue performing: Stocks and commodities up, U.S. dollar down. Yes, an extra sniff of inflation could be the consequence in a few years, but markets don't tend to think that far into the future. … I'm still in the camp that believes this recovery can right itself, and so am still (cautiously) favourable toward risk assets.
Mr. Ragan: I'm no market strategist (just ask my wife!) … but as long as rates remain low because the recovery looks (and is) fragile, it's hard to see equity markets doing anything very positive. But fixed income doesn't look like a thrill either. So perhaps we have a whack of cash just sitting around waiting for a likely change.
Mr. Parkinson : And when that change in rate policy comes - what then for the markets?
Mr. Porter: Presumably, U.S. rates will finally start to rise when the economy is finally able to stand on its two feet, so the initial phase of Fed tightening is not necessarily negative for equities. In fact, it's likely better to overweight stocks versus bonds in the early stages of Fed tightening.
Mr. Lascelles: I agree with Doug that higher rates need not be a market negative if they are viewed as an endorsement of a robust economic outlook. … Policy rates are already more stimulative than most models would suggest, which is good news for stocks and commodities. Even when central bankers start tightening, this looks set to be later than the usual profile, keeping markets contented.
THE PANEL:
Douglas Porter, deputy chief economist, BMO Nesbitt Burns
Eric Lascelles, chief economist, RBC Global Asset Management
Christopher Ragan, professor of economics, McGill University; David Dodge chair in monetary policy, C.D. Howe Institute