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Carney’s Message in a Box Cools Talk of Rapid Canada Rate Rises

Bank of Canada Governor Mark Carney
Bank of Canada Governor Mark Carney. Photographer: Tomohiro Ohsumi/Bloomberg

The Bank of Canada sent a message in a box to economists such as Bill Robson, CEO of the C.D. Howe Institute, who say interest rates must rise quickly to levels that don’t stimulate growth because the country’s economy will soon complete its rebound from recession.

The central bank used a special “technical box” near the end of yesterday’s 31-page quarterly forecast to say it could keep its policy rate at a stimulative setting even after a full recovery with inflation on target, should the economy face “headwinds” that hamper growth.

The bank said in its box its “key message” is that its policy interest rate “can return to its long-run level after inflation is projected to reach the 2 percent target and output is projected to reach its potential. This contrasts with the assumption that the policy rate should always be at its long-run level when inflation is at target and the output gap is closed.”

Governor Mark Carney amplified that message yesterday, telling reporters, “You cannot mechanically assume that because the output gap on our projection is closed in the middle of 2012, that the bank’s target interest rate will be back at neutral,” referring to an interest rate that neither stimulates or restricts economic growth.

The message comes after seven of 22 economists in a June Bloomberg survey forecast the bank would lift its key rate to 2.5 percent from 1 percent by the middle of next year -- when Carney says the economy will be at full capacity.

Clear Message

Carney’s message was clear, some economists said. “That box really caught my eye,” said Rudy Narvas, a senior economist with Societe Generale SA in New York. “It suggests that there will be pauses” in rate increases, he said by e-mail.

The technical box “is a defense against those who assert the Bank of Canada is behind the curve, which I don’t buy,” said Scotia Capital’s vice-president of economics Derek Holt by telephone from Toronto. Holt predicts a 2.25 percent rate at the end of 2012.

The bank’s argument doesn’t apply to the current situation because inflation already rose above 2 percent before the economy reached full output, Robson said. “We aren’t in the world described by the box,” he said by telephone. “This is an argument for spiking the punch bowl.”

“The bank is anxious to justify sticking with the 1 percent rate even though a lot of pretty intelligent critics have argued it’s past time” to raise it, Robson said.

Main Goal

The bank’s main goal is to keep inflation at 2 percent. Policy makers have said if the economy is operating above its potential, it can spark inflation.

A majority of nine economists on the C.D. Howe’s monetary policy council called on the bank last week to raise interest rates at its July 19 meeting, because the economy could soon be operating beyond its full potential. Some on the panel, which includes academic and financial-market economists, said “the overnight rate needs to move some distance toward a more neutral level, and should start moving soon,” the institute said.

Carney, 46, said yesterday that the box was intended to show that the bank’s policy-making isn’t automatic.

“If anyone is of the view that this is that simple, then the box serves a purpose,” Carney told reporters. The bank “doesn’t function according to some mechanical rule that dictates where monetary policy should be.”

“If we were on auto-pilot right now according to some mechanical rule, we would be ignoring the very real headwinds to this economy, from the dollar, from the U.S., from Europe,” Carney said.

While the message may damp expectations about how far and how fast the bank might move, Carney reiterated that his target interest rate for overnight loans between commercial banks, which has been unchanged since September, won’t stay at 1 percent forever.

“As the recovery continues to progress, as some of the considerable, material excess supply in the economy is used up, monetary policy can be expected to move away from exceptionally stimulative levels,” he said.

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