Stephen Poloz, Governor of the Bank of Canada, meets with the Globe and Mail editorial board on on Nov. 28, 2016.Fred Lum/The Globe and Mail
In a Bank of Canada interest-rate announcement that didn't tell us much that we didn't already know, the central bank's observation that Canada's economic recovery is different than that of the United States was, similarly, no great revelation. Yet it was probably the most important sentence in the news release.
You might easily have missed it, buried in the third paragraph of the bank's notably brief five-paragraph statement in which it held its key rate steady at 0.5 per cent (for the 11th-straight time). It looked like the bank just wanted to get out of the document without saying something it might regret later, but it took a moment, there in the mid-section of the statement, to state that "a significant amount of economic slack remains in Canada, in contrast to the United States."
Pretty much anyone who was paying attention already knew that. Still, it stood out; it is not the norm for the Bank of Canada to compare-and-contrast with the United States in its rate statement.
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This was no throwaway line. Every word in the bank's painstakingly crafted rate announcement is carefully chosen, and these weren't spilled by accident.
It's a timely reminder – especially to the bond market – that Canada's interest rates are not on the same path as those in the United States.
The Bank of Canada's rate announcement comes just one week before its U.S. counterpart, the Federal Reserve Board, issues a decision on its own interest rates, and it's a slam-dunk that the Fed will raise its key rate for the first time in a year – the start of what financial markets now anticipate could be as many as four rate hikes over the next 12 months. This amid a more generalized rising expectation of inflationary pressures in the U.S. economy, as president-elect Donald Trump looks poised to inject fiscal stimulus into an economy that is already running very close to full employment.
Those expectations have been contributing to rising U.S. government bond yields – and with U.S. bonds acting as the world's benchmark, yields throughout the global market are rising in sympathy. The yield on Canada's 10-year government bond has risen half a percentage point since early November, despite the Bank of Canada having signalled a distinctly cooler and more uncertain outlook for the far less robust Canadian recovery.
The Bank of Canada gave this bond yield run-up prominent placing in its rate announcement, and, again, that was probably no accident. In the U.S. economy, which, in the words of the central bank, "is near full capacity," higher central-bank and market interest rates are entirely appropriate. In a Canadian economy that has "a significant amount of economic slack," the higher market rates being exported from the U.S. market are decidedly unhelpful, working against a central bank that as recently as October revealed it had considered a rate cut.
As the Bank of Canada continues to play wait-and-see on a wide range of uncertainties casting a shadow over the Canadian outlook – everything from Mr. Trump's policy positions to the wobbly global-trade climate to the timing of federal infrastructure stimulus to the household-debt-fuelled housing market – it would certainly be happier if borrowing costs weren't creeping up to throw a spanner in the works. It appears it wanted to remind the market that Canada's situation is not the U.S.'s situation, and that the economic fundamentals do not justify bringing Canadian yields along for the U.S. ride.
To this end, it was telling that the central bank's rate statement emphasized some key weaknesses in Canada's economic condition while glossing over some recent strong points.
The statement made note that business investment and non-energy goods exports – which the bank has long identified as critical components of a healthy Canadian recovery – "continue to disappoint."
Meanwhile, the central bank said almost nothing about the better-than-expected quarterly gross-domestic-product data released last week, which included not only third-quarter growth that exceeded the bank's estimate, but also upward revisions of first- and second-quarter GDP above the levels the bank had already baked into its economic calculations. Those numbers suggest that the Canadian economy has less slack in it than the bank had thought it would at this stage – but the bank took a conspicuous pass on addressing that development.
The statement's focus and tone effectively revived the possibility that the Bank of Canada might still cut rates in the first quarter of 2017 – which was already dampening short-term Canadian yields in the hours following the announcement. If the bank's message continues to sink in with bond traders, this rate announcement will have succeeded in buying the bank some time, and some relief from rising yield pressures, while the uncertain outlook becomes clearer.