The Bank of Canada will probably need to cut interest rates to historical lows to stave off a deepening malaise as the nation’s economy runs out of growth drivers.
Policy makers reduced the benchmark rate to 0.5 percent Wednesday, the second cut this year, and chopped their 2015 growth forecast almost in half to 1.1 percent as the export rebound fails to materialize. Their revision to the 2015 net export forecast, to 0.3 percent from April’s 1.1 percent, was even more dramatic.
Bank of Canada Governor Stephen Poloz, who since 2013 has predicted shipments abroad will take over from consumer spending as one of the main engines of growth, called the extent of the current export weakness “puzzling.” Poloz may have no choice but to extend rate cuts, even with the currency depreciating to the lowest since 2009.
“The weaker currency so far hasn’t translated into benefits in non-energy exports and we will need to see that improve,” said Ben Homsy, a fixed-income analyst in Vancouver at Leith Wheeler Investment Counsel Ltd., which manages C$17 billion ($13 billion) in assets. “Otherwise I think the bank will cut again.”
With Wednesday’s rate reduction, Poloz is just a step away from returning the benchmark interest rate to 0.25 percent, which would match the record-low level set by his predecessor Mark Carney during the 2008-2009 credit crunch. The central bank said Canada’s economy probably contracted moderately in the first half, stopping short of calling it a recession.
Canada’s dollar dropped to as low as C$1.2958 per U.S. dollar after Wednesday’s decision, the weakest since 2009, and two-year government bond yields fell to 0.39 percent from 0.46 percent.
An almost 20 percent decline in the currency over two years probably isn’t enough to regain the share of the U.S. market lost to exporters from countries like Mexico, investors said. The damage from tumbling oil prices that triggered Canada’s latest economic decline may be more widespread than the bank first expected, with policy makers now predicting investment from oil firms will drop 40 percent this year, from 30 percent in April.
Even after the latest disappointment, the bank still expects an export-led recovery. However shipments may remain weak because of “fundamental competitiveness challenges,” as Mexico and Europe, whose currencies have also dropped relative to the greenback, grab a bigger share of the U.S. export market, the bank said.
Falling mineral and metal exports led to a fifth-straight decline in May, making the cumulative year-to-date trade deficit the largest on record, Statistics Canada data show.
Poloz told reporters he has “a fair bit of room to maneuver” if more stimulus is needed, citing tools such as quantitative easing Canadian officials outlined during the financial crisis. QE is when a central bank whose policy rate is at or close to zero undertakes large-scale debt purchases to lower market interest rates. Canada didn’t embark on QE during the most recent global crisis.
Emanuella Enenajor, senior Canada economist at Bank of America Merrill Lynch in New York, said Poloz will cut again in January. She cited “still optimistic hopes that non-energy exports will pick up and drive growth in the second half of 2015 and 2016,” in a research note.
The bank’s forecast is for output to swing from a 0.5 percent annualized contraction in the second quarter to an expansion of 2.6 percent between January and March of next year.
One problem with more rate cuts is the risk of stimulating the wrong parts of the economy, such as consumers who already hold record debt burdens instead of energy and manufacturing companies.
John Kim, a fund manager at Aston Hill Financial Inc. in Toronto, which manages about C$4 billion, doesn’t see the point in further monetary stimulus.
“Borrowing rates are so low anyhow that another 25 basis point rate cut, will that do much? I’m somewhat skeptical on it,” he said.