Two rate hikes in three months and no sign of inflationary pressures in sight.
The Bank of Canada’s surprise decision to tighten policy again on Wednesday night may provide a whiff of a different approach to monetary policy setting: one that blazes the trail for central banks in other advanced economies to tighten policy even in the absence of the traditional triggers such as climbing wages and consumer prices.
Bank of Canada governor Stephen Poloz may be blazing the trail for his peers in other advanced economies, including our own. Photo: Bloomberg
Canadian policymakers raised their benchmark rate 25 basis points to 1 per cent, the second increase since July. At the same time, they cited a litany of risks that have kept most of their peers on the sideline.
Governor Stephen Poloz pointed to continued excess capacity, subdued wage and price pressures, fraught geopolitics and the higher Canadian dollar, along with concern about the impact of rising interest rates on heavily indebted households.
All of those worries would be instantly recognisable to Reserve Bank of Australia boss Philip Lowe. The difference is that Canada’s economy is running hot.
Real GDP grew by 4.3 per cent year-on-year to June, against Australia’s 1.8 per cent. Canada’s growth is way ahead of other major economies, too. Britain’s economy is expanding at a rate of 1.7 per cent, the Eurozone at 2.2 per cent and Japan at 2 per cent.
With those growth rates, perhaps economists shouldn’t have been as surprised as they obviously were – only six of the 26 experts surveyed by Bloomberg leading into Wednesday night’s decision picked a rate hike.
“The Bank of Canada has been consistently hawkish since June and the markets keep underestimating their resolve,” BT Investment Management head of fixed income Vimal Gor said.
“Given their comments, it is likely that the BoC will continue to hike the interest rate up to its neutral rate, and the economic data is certainly strong enough to warrant that.”
The Canadian and Australian economies are similar. Both are resource-rich nations, with ramping risks in overheated residential property markets. Australian and Canadian households both labour under historically high levels of debt.
Those similarities, however, do not imply the RBA is about to follow its Canadian counterpart.
“There’s no implication for the RBA from the BoC at all,” Mr Gor said. “Our economies are in very different shape.”
TD Securities rates strategist Annette Beacher does see “parallels” between the two. “While one central bank may not necessarily ‘follow’ the other, both seem to be headed down the same route,” Ms Beacher wrote in a note to clients earlier this week.
“Interestingly, in its latest [Statement on Monetary Policy] the RBA noted that the adjustment to lower levels of mining investment is largely behind us, a phrase that rings similar to the BoC’s May communique. Taking a step further, both central banks have taken the stance that this development also implies that the drag from business investment should dissipate.”
The BoC’s rate hikes are unlikely to spark a rash of copy cat moves here. But perhaps more importantly, they provide a precedent for monetary policy tightening even in the absence of inflationary pressures.
“Given the stellar growth they [Canada] continue to enjoy, I think they are more inclined to stay the course and focus on financial system risks from extraordinary stimulus settings despite lower than traditional levels of inflation,” Altius Asset Management chief investment officer Bill Bovingdon said.
Mr Bovingdon argues that the forces which have led to persistently subdued consumer price growth in advanced economies – or “lowflation” – is structural, rather than cyclical. It’s “a function of technology and globalisation, which is a shock equivalent to the industrial revolution,” he said.
Fighting the impact of such factors with monetary policy “is folly”.
“It just inflates asset prices and worsens income inequality.
“I think there’s a realisation within central banks that the disinflation we are seeing globally is being driven by structural supply-side changes,” Mr Gor agreed. “As such, they are much more likely to look through these and hike rates if GDP growth is strong.
“I believe that we will see an environment of growth surprising to the upside and inflation surprising to the downside globally over the coming years.”
If Mr Gor is right, then the Bank of Canada this week may have provided the blueprint for central bank action in just that kind of environment.