- Global counterparts seen lowering borrowing costs on Brexit
- Hot housing market likely to constrain Bank of Canada
Alberta wildfires. A stagnant labor market. Elusive export growth. Weak commodity prices. Disappointing global demand. And now Brexit.
Canada’s economy faces a seemingly endless array of impediments. Yet while Group of Seven counterparts including Bank of England Governor Mark Carney are expected to cut rates to absorb similar setbacks, here’s why Bank of Canada Governor Stephen Poloz will probably refrain from taking that path at his next decision Wednesday.
The Housing Market is Too Hot
Lowering rates from the current 0.5 percent would potentially stoke further housing gains in Vancouver and Toronto, where prices have already surged 32 percent and 17 percent respectively over the past year, even as policy makers warn about strapped consumers and the risks to the financial system.
Cutting rates “would just add fuel to the fire,” said Scott Smith, senior market analyst at Cambridge Global Payments in Calgary. “You get the potential to see those overheated housing markets in Vancouver and Toronto get worse.”
The U.S. Recovery Will Overshadow Brexit
Although Canada had its origins as a British colony, it’s the U.S. relationship that counts now. Total trade between Canada and the U.S. amounted to $541 billion in 2015, dwarfing the $21 billion total with the U.K. “In terms of Canada’s trade abroad, the U.S. is the skyscraper,” Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce in Toronto, said last week in an interview with Bloomberg TV Canada’s Pamela Ritchie.
Canada’s prospects got a boost on Friday after a report showed U.S. payrolls climbed by 287,000 last month. Also U.S. factory activity expanded in June at the fastest clip in more than a year. The data suggest the American economy is in better shape than Europe’s, and that Canada has more breathing room than regions more directly affected by the U.K.’s June 23 decision to leave the European Union.
The odds of a Bank of England rate cut on Thursday are about 79 percent, trading in interest-rate derivatives show, while the probability of a European Central Bank cut sometime this year is almost 70 percent.
The trading shows the implied odds of a Canadian cut are about 26 percent this year, and only 10 percent Wednesday. All 27 economists in a Bloomberg survey predict Poloz will stay on the sidelines this week.
A Rate Cut Would Shake Business Confidence
Since taking over as central bank governor in 2013, Poloz has predicted exports and business investment would lead a recovery. While these two drivers have been slow to materialize, the governor has stuck to his guns, saying as recently as last month his “core forecast narratives” around U.S. growth and Canadian exports “remain intact.”
After all, Poloz can point to some positive signs, including strong export gains in sectors such as automobiles and lumber.
Then there’s the added boost from Prime Minister Justin Trudeau’s fiscal stimulus -- budgeted at about C$120 billion ($91.4 billion) over six years -- that policy makers have said will make a difference.
Analyst say a rate cut would signal the central bank’s hopes are fading. “It could be bad for sentiment, like a self-fulfilling prophecy,” said Thorsten Koeppl, associate professor at Queen’s University in Kingston, Ontario.
To be sure, Poloz can’t hold out forever if his narrative fails to gain traction.
“I would expect the Bank of Canada to soften its tone a little bit,” this time, said Citigroup Global Markets Economist Dana Peterson, who sees a cut in the fourth quarter. Canada is too “sensitive” to global factors like commodity prices.