It came as a shock to just about everyone when Bank of Canada Governor Stephen Poloz announced the central bank would lower its benchmark lending rate in January to 0.75%.
That’s because after more than four years with a historically low 1%, Canadians had been hammered with repeated warnings to pay down debt because lending rates were bound to go up at some point, Pete Evens wrote for CBS News.
Then a huge slump in oil price changed the narrative. When the bank cut rates in January, it was six months into an oil drop that saw crude go from $95 a barrel this time last year to under $50. That was devastating for the oil patch—but also for the rest of Canada’s economy.
“This decision is in response to the recent sharp drop in oil prices, which will be negative for growth and underlying inflation in Canada,” the bank said in explaining its bombshell rate cut.
Eye on Inflation
Although the bank keeps an eye on all sorts of economic data, the most important one from a monetary policy perspective is inflation—the upward creep of prices over time. The bank has a mandate of inflation targeting because according to many economists, if you can keep inflation in a narrow band between 1% and 3%, everything else in the economy—from jobs, to GDP and the like—tends to take care of itself.
Lower lending rates make borrowing easier, which stimulates spending and investing, which nudge up inflation. Raising rates does the opposite. At least, so goes the theory.
When the bank cut rates in January, it raised the possibility of another one down the line. With Canada’s inflation rate currently at 0.9%, there would seem to be ample wiggle room to cut again.
Although Poloz and company declined to do so in subsequent meetings in March, April and May, another cut is very much on the table. Opinion is divided, however, as to whether that’s a good idea: About half of the 35 economists Bloomberg monitors on the subject expect a cut. The remainder expects the rate to stay the same.
Economy Shrinking
Among those who say the bank needs to cut is David Madani, an economist with Capital Economics in Toronto. His main reason for advocating has nothing to do with inflation and is instead rather simple: The economy is shrinking.
Official GDP data from Statistics Canada show that the economy has shrunk in each of the first four months of this year—two months away from the technical definition of a recession. In April, the central bank said it was expecting 1.8% growth for the first two quarters, an assumption that seems out of reach now.
The economy would have to grow by 0.6% in both May and June to achieve that. “Considering the impact we already know that things like Alberta wildfires have had on the economy, the odds of the economy growing by 0.6% are about as high as Europe’s lenders forgiving Greece’s debts,” Madani says.
“It’s hard to see how the bank could not cut rates when the economy is in recession,” he adds. Indeed, it’s for this reason Madani is calling for not only a cut to 0.5% on Wednesday, but another one to take the rate to 0.25 by year’s end.
Indeed, there’s a growing view that’s questioning whether a cut would even have the desired effect.
The bank cuts rates to stimulate investment and increase access to money, aiming to help growing businesses. But there’s a lot of data to suggest that good businesses already have plenty of access to money. Official data show corporate credit is growing by 8.7% year over year—the fastest pace of growth since 2007.
