Poloz Counsels Patience as Canada Waits for Investment

Stephen Poloz, the new Bank of Canada governor, has a message for debt-laden Canadians awaiting exports and business spending to lead economic growth: be patient, and keep spending less.

Canadian companies are increasing their investment plans at the slowest pace in three years, while the household debt-to-income ratio is close to a record high. Poloz, who forecast this week that business outlays will triple their contribution to economic growth in 2014, said there’s little he can do to speed up a needed rotation of demand from consumers to businesses.

“This is the natural course of events,” Poloz, 57, told reporters in Ottawa on July 17 after his inaugural interest-rate announcement. “What we require now is a little bit of patience as opposed to somehow trying to force something to happen.”

Poloz left his benchmark rate at 1 percent, the highest among Group of Seven central banks, marking the 23rd consecutive meeting with no change. In continuing the longest interest-rate pause since the 1950s, Canada stands in contrast with peers such as the U.S. Federal Reserve and Bank of Japan, which are continuing or expanding extraordinary measures aimed at spurring domestic demand.

China also took steps to bolster its economy, removing the floor on lending rates offered by the nation’s financial institutions as economic growth slows, the People’s Bank of China said in a statement on its website.

Spending Trigger

More orders from the U.S., Europe and Japan are needed to boost exports and trigger the spending that will lead to a stronger Canadian expansion, Poloz said. The weakness of domestic demand was underscored by a report today showing that inflation fell short of the central bank’s 2 percent target for a 14th straight month. Retail and factory sales have been little changed for a year, Statistics Canada data show.

“There is no pent-up demand in the domestic economy,” said Jeff Herold, who helps oversee C$2.5 billion ($2.4 billion) as lead fixed-income manager at J. Zechner Associates Inc. in Toronto. “We need to see some external drivers, either some business investment or business growth, so we are somewhat dependent on U.S. and global growth to see a better economy in Canada.”

The International Monetary Fund says the country’s 1.7 percent growth this year will be among the slowest in the Group of 20 nations outside of Europe. Canada’s dollar has weakened by 0.9 percent over the last month on signs that the U.S. economy is growing faster. Canada’s benchmark stock index is underperforming U.S. equities for a third year after seven years of stronger gains, while government bond yields have also risen less than Treasuries, suggesting investors are expecting less of a rebound in growth in Canada.

Canadian Dollar

The Canadian dollar was little changed following today’s inflation report, trading at 1.0366 per U.S. dollar at 4:33 p.m. in Toronto, up 0.1 percent from late yesterday. Canadian stocks rose, with the Standard & Poor’s/TSX Composite Index gaining 56.28 points, or 0.5 percent, to 12,685.13.

Consumer spending spurred by cheap borrowing costs pulled Canada out of the most recent recession faster than other Group of Seven nations, leading to a record household debt-to-income ratio.

“Don’t expect Canada to be outperforming its peers now because those sectors that pushed Canada above the rest, those are fading now,” said Krishen Rangasamy, senior economist at National Bank Financial in Montreal. “It’s a good thing because we need to get to a point where housing and credit accumulation slow to a more sustainable path.”

Growth Model

Poloz has said that the model of growth led by debt-fueled consumption is reaching its limits. Canada’s debt-to-income ratio was 161.8 percent in the first quarter, down from an all-time high of 162.8 in last year’s third quarter.

“The household sector has done a lot of heavy lifting through this cycle,” Poloz said. “Those levels of debt are large and so it’s comforting to us to see them drifting down.”

Finance Minister Jim Flaherty has echoed the central bank’s warnings about debt. Flaherty tightened mortgage rules for a fourth time last year and has warned about the risks of overbuilding in Toronto and Vancouver, the country’s largest and third-biggest cities.

While consumers responded to low interest rates, Canadian businesses have yet to follow suit. Oil and gas companies, which account for almost half of all business investment by firms listed on the Toronto Stock Exchange, are planning C$18.2 billion in spending this quarter, down 1.5 percent from a year earlier.

Investment Plans

The Bank of Canada’s latest survey of corporate executives, published last week, showed machinery and equipment purchase plans at the second lowest level since 2009 as the last recession ended.

Canadian firms had a record C$544 billion in cash on their balance sheets in the first quarter, suggesting ample capacity to invest. While Poloz’s predecessor, Mark Carney, said that they should either spend this “dead money” or return it to shareholders, Poloz -- who worked closely with companies during a 14-year career at the country’s export financing agency --says firms are acting with understandable caution.

“If you were making those decisions you’d want to be more sure too, because this is real money that’s going on the line,” Poloz said this week.

Russ Girling, chief executive officer of TransCanada Corp., the Calgary-based firm that’s proposed building the Keystone XL pipeline, shares this caution.

‘Fragile’ Economy

The Canadian economy “continues to be fragile and it’s somewhat dependent on what happens globally,” Girling said in a July 18 interview at Bloomberg’s headquarters in New York.

The central bank forecast the contribution to economic growth from investment will triple to 0.6 percentage point next year and then rise to 0.9 percentage point in 2015.

“I’m highly skeptical, and I have been all along, that business investment can lead growth,” said Doug Porter, chief economist at BMO Capital Markets in Toronto. “Investment is a very late-cycle mover.”

Flaherty’s plan to eliminate a budget deficit by the next election in 2015 also rules out much of a boost from government spending, Porter said.

In the absence of rapid growth in exports and investment, Canada’s key interest rate will probably stay at 1 percent until the fourth quarter of next year, according to a Bloomberg survey.

“Is there something else that we can do at this stage?” Poloz said at a June 19 event hosted by the Oakville, Ontario, Chamber of Commerce. “We would say ‘Well, no.’”

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