With world conditions tying Carney’s hands, expect continued low interest rates

OTTAWA – Bank of Canada governor Mark Carney chafes at any suggestion his hands may be tied on monetary policy.

OTTAWA – Bank of Canada governor Mark Carney chafes at any suggestion his hands may be tied on monetary policy.

“We make monetary policy for conditions in Canada,” he shot back in July to a reporter’s suggestion he is out of step with his colleagues in maintaining a tightening bias during a global slowdown.

Since then, he has been proven somewhat correct in predicting that second quarter output in Canada would come in at 1.8 per cent, modest but still safely in the black side of the ledger.

But with another interest setting day Wednesday, the central banker likely knows he has little choice but to keep the overnight policy rate fixed at one per cent — marking two full years of inaction on the key tool the bank has to influence economic direction in the country.

Private sector economists say they see Canadian interest rates at the current low rates far into the future — certainly until the spring of 2013, if not the fall of next year or even to 2014.

Last week, the C.D. Howe’s unofficial monetary policy council voted 11-1 to keep the rate unchanged, the only dissenter — professor Nicholas Rowe of Carleton University — opting for a 25-basis point shave.

Interestingly, the consensus was for the rate to stay glued at one per cent six months from now, and three of the 12 say the bank’s next move should be to cut rates rather than hike them.

The reasoning has nothing to do with what is occurring in Canada and everything to do with happenings beyond its borders and beyond Carney’s reach.

In an analysis titled “Days of Decision” issued Tuesday, TD Bank chief economist Craig Alexander describes the global economic landscape as being at a tipping point awaiting the action or inaction that could set it on the road to recovery or to doom.

The trouble is the decisions will need to be made outside Canada’s borders.

“How the ECB (European Central Bank) deals with policy in the near term, and decisions by the U.S. Federal Reserve, could be more important to Canada than actions taken by the Bank of Canada in the near term,” he said.

First up will be the ECB meeting Thursday, when head banker Mario Draghi is expected to put some meat in the bones of his earlier pledge to do “whatever it takes to preserve the euro” in the face of ever increasing demands for bailouts from Spain and Greece.

And Fed chairman Ben Bernanke will likely be next up with a decision on whether to launch another round of quantitative easing — printing more money to buy bonds — in another effort to light a fire under the dormant U.S. economy.

A further critical juncture occurs later this fall after the U.S. presidential election when the lame-duck Congress will be put to the test on extending tax measures and delaying cost cuts that by most estimates would knock about 3.5 percentage points off American growth, such as it is.

Recently, the impartial Congressional Budget Office said the U.S. economy would fall back into recession if the so-called “fiscal cliff” is not avoided.

“The Bank of Canada will want to see how events play out before acting,” said Alexander.

Fortunately, Carney has some flexibility. The domestic economy is neither so strong that it would require interest rate tightening, nor too weak that a rate cut, which some economists are urging, is imminent. As well, despite an expected boost from food prices as a result of the drought in the U.S., inflation remains well anchored and below the bank’s two-per-cent target.

The one danger in maintaining the current low rate is that Canadians will take the cheap money and pour it into the housing market, piling up more debt and risk.

Events are giving Carney some comfort on that front as well, however.

“It’s too early to say the housing market has cooled off sufficiently, but from most policy-makers’ view, it is moving in the right direction now,” said Doug Porter, deputy chief economist with BMO Capital Markets.

Porter said he doesn’t believe Carney will move on interest rates until late 2013, but adds the governor is likely to keep the tightening bias in the announcement news release, which is pored over by markets and economists like tea leaves by fortune tellers.

Nobody will be fooled, however, Porter adds. “It’s very mild in any event,” he says of the bias. “All they (bank) are saying is the next move will be higher, but the next move could be years from now.”

Looking for more?

Get the Best of Maclean's sent straight to your inbox. Sign up for news, commentary and analysis.