Bank of Canada Retains 0.50% Overnight Interest Rate Target

January 20, 2016

Central banks are in the first stage of grief over what’s transpiring in financial markets this year, and the Bank of Canada is no exception.  The take-away from today’s released statement is that policymakers are in a state of denial.  Yes, forecast adjustments have been made in the face of year-to-date declines in the Toronto Stock Exchange index of 10.8%, in WTI oil prices of 27.3%,  and the 10-year Canadian bond yield of 29 basis points to 1.10%.  To wit, projected real GDP growth has been lowered to 0.8% from 1.4% for the current calendar quarter and to 1.4% from 2.1% in the next quarter, and the anticipated date for returning to full employment has been pushed out to end-2017 from the middle of that year, which had been presumed in the prior quarter review.  And yes, total CPI inflation in this year’s spring quarter was cut to 1.1% from 1.5% assumed before. However, beyond the months immediately ahead, the forecast quickly converges on what officials had been expecting.  The current meltdown is too dire to be a new reality, so it’s identified but characterized as having little lasting effect.  This is conveyed by several assertions.

The dynamics of the global economy are broadly as anticipated in the Bank’s October Monetary Policy Report (MPR).

Global growth is expected to trend upwards beginning in 2016.

Prices for oil and other commodities have declined further and this represents a setback for the Canadian economy. GDP growth likely stalled in the fourth quarter of 2015, pulled down by temporary softness in the U.S. economy, weaker business investment and several other temporary factors. The Bank now expects the economy’s return to above-potential growth to be delayed until the second quarter of 2016.

All things considered, therefore, the risks to the profile for inflation are roughly balanced. Meanwhile, financial vulnerabilities continue to edge higher, as expected. The Bank’s Governing Council judges that the current stance of monetary policy is appropriate.

Bank of Canada policymakers approved new forecasts that keeps core inflation in the final quarter of 2016 at 2.0%, same as assumed in October’s review.  Real GDP next year is forecast to be 2.4%, just 0.1 percentage point lower than before and above the assumed pace of potential GDP.  Like many central bankers, they consider their policy stance to be highly accommodative already after cuts of 25 basis points implemented in January and July of 2015.  But the Bank of Canada never engaged in quantitative stimulus, and its key rate has barely changed since 2009.  The target was lowered during the Great Recession to 0.25%, then raised at three consecutive meetings by 25 basis points each in June, July and September 2010.  The only other two changes were the aforementioned two cuts in 2015.  When policy settings are as static as this, the best way to assess if monetary policy has been just right, too loose, or not loose enough is by comparing actual inflation versus targeted inflation and actual GDP growth to expected GDP growth.  Total inflation is below target, and Canada experienced an unexpected recession in the first half of last year and likely zero growth, by the latest statement’s own admission, in the final quarter of the year.  It’s going to be a tough sell for the Bank of Canada brass or those at other central banks trying to persuade the public to be patient with current market conditions and to accept that the volatility is temporary and will hardly affect economic growth beyond mid-year. 

Copyright 2016, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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