How long will rates stay low?

Oct 20, 2009

Low rates look safe for a while

With Canada’s economy looking perkier than expected and Australia’s central bank having sprung the world’s first rate-hike surprise two weeks ago, murmurings have arisen that the Bank of Canada could tiptoe a bit closer to a rate increase of its own today. Not likely. It’s true that Canada is emerging as one of the strongest economies among wealthy industrial nations, which means it could theoretically be compared to Australia, since any sustained strength could suggest a need to rein in the ultra-low interest rates promised by the Bank of Canada for most of the coming year. But it also is true for each sign of strength – rising resource prices, surprisingly resilient job growth, booming housing sales – there are countervailing arguments that this country needs an extended period of credit coddling. Indeed, it’s hard to find anybody that seriously thinks there’s a chance of an actual rate hike from the ultra-low 0.25 per cent rate that our central bank has promised to maintain – short of an unexpected inflation problem – through June 2010. Any hint of tightening, then, would come in the wording of the Bank of Canada’s statement renewing this commitment. If the commitment looked a little less solid than in past statements, it would be taken as a sign that monetary policy – which can take a year or more to have much impact on the real economy – might be tightened earlier than expected, or at least that rates would be hiked faster than expected once the central bank’s promise expires. Some are betting on this already, with the interest rates on longer-term lending drifting up in recent weeks, reflected in a rise of one-quarter of a percentage point or more in the rate on a five-year bond or mortgage. The bond-market bets that produced this increase could well prove to be good ones if Canada’s economic recovery proves to have legs. Strong growth this time next year would create both a stronger demand for credit and a greater potential for inflationary pressure if rates stay too low. But that’s more likely to lead to rapid hikes after June than an early start to such a campaign, since premature tightening could tip the economy back into stagnation. And that’s a decision for another day. The logic behind the central bank’s rate commitment looks so strong at the moment that it seems unlikely to be in danger. First, any hint of an early rate hike would drive our soaring loonie still higher, the last thing wanted by the central bank at a time when exporters are already feeling strain. As well, Canada is not Australia. Canada is similar to Australia in that it’s a big resource exporter and, therefore, benefits from the bounce in resource prices over the past several months, but Australia’s customers are in Asia, the world’s fastest-growing region. Our customers are in the still-struggling U.S. This matters. It matters so much that Australia actually had no recession, just a brief slowdown in its growth. Australia’s unemployment rate is 5.4 per cent vs. Canada’s 8.4 per cent, notes Eric Lascelles, chief economics and rates strategist at TD Securities. With high unemployment and serious distress in manufacturing, Canada’s economy still needs a while to get its recovery up to speed. An even more powerful argument is there’s absolutely no sign that inflation is accelerating. While it’s true that a key market, the one for home resales, has seen a remarkable rebound in the past year, there doesn’t seem to be much inflation built into housing yet. Overall, the core inflation rate – the one that excludes volatile items and is tracked closely by economists – shows no sign that Canada needs higher interest rates, suggests senior economist Michael Gregory at BMO Capital Markets. The Bank of Canada has estimated the core rate would average 1.4 per cent in the final three months of this year and the first three months of 2010. But the latest numbers suggest it’s actually likely to be a little lower than this forecast, Gregory says. If anything, this could suggest that the bank might feel comfortable maintaining its low rates even longer than promised. jbryan@thegazette.canwest.com