The Bank of Canada signaled it may seek to curb record household debt levels by raising interest rates for the first time in more than two years, sharpening the divide with other Group of Seven nations focused on easing policy to combat a cooling global economy.
Governor Mark Carney said in Ottawa today that “some modest withdrawal of monetary policy stimulus will likely be required,” even as it kept the benchmark rate at 1 percent, and that “imbalances in the household sector” will influence the timing of any move. Strategists such as Jimmy Jean at Desjardins Capital Markets in Montreal predicted the central bank would drop or weaken its tightening bias.
Canada’s banking system and housing market were unscathed by the global financial crisis, allowing the world’s 11th largest economy to recover ahead of other G-7 countries. The bank said in July that the expansion is threatened by consumer debt that’s climbed to 165.8 percent of disposable income, higher than the U.S. peak before its property bubble burst. Canadian house prices have risen 56 percent since June 2005.
“They kept the hawkish bias as a warning to consumers and to curb the real-estate market,” said Denis Senecal, vice president and head of fixed income and cash for State Street Global Advisors, Canada, which manages C$1.4 trillion ($1.41 trillion) of assets.
Carney also said that household debts, already at record levels, will rise further. His concern has intensified since April, when he said monetary policy should be the “last line of defense” against high debt. Canadian Finance Minister Jim Flaherty told CBC Radio Oct. 20 that he isn’t planning further measures to restrain the housing market because steps to tighten mortgage regulations have already slowed gains in some of the country’s major cities.
Canada’s dollar erased a loss after the decision. The currency was little changed at 99.24 cents per U.S. dollar at 5 p.m. in Toronto after falling as much as 0.5 percent before the announcement. One Canadian dollar buys $1.0077.
Trading in overnight swaps showed investors had swung to betting on a rate increase instead of a cut by the bank’s May 2013 meeting.
“The Bank surprised us and Bay Street by amping up the hawkish tone in its statement,” said Carl Weinberg, chief economist at High Frequency Economics in Valhalla, New York, making a reference to the Toronto street that has a cluster of banks. “The notion of raising interest rates now is just plain bad policy,” he said, citing moderate economic growth following a “big downturn” and slow inflation.
Canada’s bias to boost borrowing costs contrasts with easier monetary policies introduced in recent months by the Federal Reserve and the European Central Bank. The Fed last month announced a third round of quantitative easing, with monthly purchases of $40 billion of mortgage-backed securities.
Bank of Spain
Elsewhere today, the Bank of Spain said the nation’s economy contracted for a fifth quarter, adding pressure on Premier Mariano Rajoy to seek more European aid. Gross domestic product fell 0.4 percent in the three months through September from the previous quarter, matching the contraction of the second quarter. The euro weakened and Spain’s 10-year bond yield rose after the data.
In the U.S., Fed policy makers began a two-day meeting in Washington today. All 21 bond dealers that trade with the Fed expect it to decide before year-end to buy Treasuries in addition to purchasing mortgage bonds as gains in U.S. employment and consumer confidence prove unsustainable, according to a Bloomberg survey.
In an Oct. 15 speech, Carney left out a reference to tightening monetary policy. At the same time, he foreshadowed today’s statement by saying that “if we were to lean against emerging imbalances in household debt, we would clearly declare we are doing so.”
Caught by Surprise
“The bank caught the market a little bit by surprise on this one,” Mazen Issa, Canada macro strategist at Toronto-Dominion Bank’s TD Securities unit, said in a phone interview. “Their fidelity toward their hawkish bias has been tested and will continue to be tested over the coming months.”
The Bank of Canada said today the country’s debt burden will keep rising before “stabilizing” by the end of 2014.
Statistics Canada said Oct. 15 said credit-market debt was higher than earlier estimated while incomes were lower, increasing the ratio of debt to disposable income 10 percentage points to levels above the U.S. peak in 2007.
“Households need to slow their borrowing on their own, or else the Bank of Canada will give them a reason to do so,” Avery Shenfeld, chief economist at CIBC World Markets in Toronto, wrote in a client note.
Canada is at risk of a second recession since 2009 because record debt may force households to curb spending, according to a Sept. 6 Moody’s Analytics report.
The Bank of Canada today forecast that consumer spending and business investment will help bring the economy back to its full capacity by the end of next year. It raised its 2012 growth forecast to 2.2 percent from a July prediction of 2.1 percent, and repeated that growth will be 2.3 percent next year.
Stock investors may also be betting that consumer spending will remain healthy. Consumer discretionary companies on the Toronto Stock Exchange such as the movie-theater chain Cineplex Inc. have returned 12 percent this year, lagging only health-care companies with a 20 percent return.
The Bank of Canada repeated that Canada’s dollar will be a source of weakness along with “global headwinds.” Prices for Canadian commodity exports have still increased in recent months even with a “gradual” U.S. recovery, a recession in Europe and slower growth in China, the Bank said.