BMO’s Porter Says Rate Cut May Create Grotesque Canada Debt Skew

The Bank of Canada’s surprise cut to borrowing costs this week threatens to tilt an already lopsided economy into one that is grotesquely skewed toward housing and consumer spending, said Bank of Montreal’s Doug Porter.

Governor Stephen Poloz cut the central bank’s benchmark rate to 0.75 percent two days ago, a move he called insurance against the damage wrought by plunging oil prices on the world’s 11th-largest economy. Porter, Toronto-based chief economist at the nation’s fourth-largest lender, says the move risks backfiring.

“Far from helping growth, the rate move could actually increase consumer and employer anxiety and uncertainty,” Porter wrote in a note to clients today. “More fundamentally, the economy’s shape is arguably already heavily skewed by the persistence of negative real interest rates, and the cut threatens to make the skew grotesque.”

Until two days ago, the Ottawa-based Bank of Canada held its benchmark interest rate at 1 percent for more than four years even in the face of a housing market that some analysts and policymakers said was at risk of overheating. Negative real interest rates -- where borrowing costs are lower than the inflation rate -- may spur consumers to borrow more, exacerbating household debt levels that hit a record last year.

The yield on five-year government benchmark bonds fell to 0.78 percent today, about half the annual rate of inflation of 1.5 percent as reported by Statistics Canada, based on the December Consumer Price Index.

‘Dangerously Lopsided’

The central bank has pointed to signs of slack in the economy and labor market as a rationale for keeping the benchmark rate at 1 percent, rather than raising it, which would have dissuaded consumers from borrowing more. Poloz said the economy requires exports and business spending to lead the economic recovery.

“The economy just relied so much on housing and consumer spending,” Porter said in a telephone interview. “It’s become almost dangerously lopsided and this will do nothing to help.”

Data suggest the economy still has some momentum. Canada’s output will expand at a 2.1 percent annual pace this year and 2.4 percent next year, the Bank of Canada said in this week’s updated forecasts, which took into account the new stimulus and oil prices that have plunged by about half in six months.

Porter predicts Poloz will cut borrowing costs again at the next meeting in March, after the Wednesday cut took almost everyone by surprise, including the 22 economists in a Bloomberg News survey who forecast rates wouldn’t change.

“I don’t feel a great deal of confidence in trying to predict them now,” Porter said.

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