Poloz Arrives at Crossroads With Canada Recovery in Tatters

  • Investors and economists almost evenly split on odds of cut
  • Central Bank also releasing quarterly economic forecasts

QuickTake: Canada's Next Step

Stephen Poloz is in a no-win situation.

As the Bank of Canada governor prepares to release his interest rate decision, forecasters are about evenly split on whether he’ll cut the benchmark rate to 0.25 percent or leave it at 0.5 percent. A cut risks adding to an already epiccurrency slump and may do little for growth; standing pat gives the impression the central bank is cold to the widening damage from collapsing oil prices.

As if that wasn’t enough, extraordinary policy tools such as negative rates are now on the table for the first time in the central bank’s 80-year history. Poloz is approaching uncharted territory, and the stakes are high: there’s speculation the economy, which is still convalescing after two quarters of contraction in the first half of 2015, is at another tipping point.

“It’s not going to take a lot to shock the system and push us into a recession,” said John Johnston, chief strategist at investment manager Davis Rea Ltd. in Toronto. “The Bank of Canada will cut rates, it’s a no-brainer. If he doesn’t he will get crucified.”

Others say lower rates won’t accomplish much, and it’s time to let the economy adjust.

“Why would Poloz do another rate cut? To me that doesn’t make any sense,” Martin Pelletier, managing director and portfolio manager at TriVest Wealth Counsel in Calgary, said in a Jan. 15 phone interview. “The dollar has already fallen below 70 U.S. cents so it should be doing its magic. Why do you need to lower rates?”

Investors are now assigning 57 percent odds Poloz will cut the overnight rate, up from 13 percent a month ago. Three of Canada’s biggest lenders changed their forecast to a cut last week, bringing the total in a Bloomberg survey to 16 out of 34 economists predicting lower rates. Poloz’s decision is due at 10 a.m. from Ottawa.

The loonie, as Canada’s currency is known, has depreciated 17 percent against the U.S. dollar over 12 months, tracking the price of U.S. benchmark crude which has plunged to below $30 a barrel. Policy divergence -- the Federal Reserve is raising interest rates, and odds are Poloz will cut at least once this year -- is adding momentum to the currency’s decline. A rate reduction now would drop the Bank of Canada’s benchmark rate below the Fed’s for the first time since 2007. The loonie extended its record streak of declines, falling for a 14th-straight session Wednesday to C$1.4619 per U.S. dollar. A dollar buys 68.4 U.S. cents.

There’s an argument to be made that Poloz has done enough, having already lowered the benchmark rate twice last year, in January and July, and now it’s the government’s turn to ramp up spending. Prime Minister Justin Trudeau’s debut budget is due by April. Trudeau has already backed off a campaign pledge to cap deficit spending at C$10 billion annually. Former Bank of Canada Governor David Dodge recommends federal and provincial governments run combined deficits of as much as C$40 billion a year.

All of that would take time, something the economy may be running out of.

In its last monetary report, the central bank predicted Canada will return to full capacity with inflation at the 2 percent target by the middle of next year. It also projected GDP growth of 2 percent this year. However with the oil shock still reverberating, and the benefits from a currency at 69 U.S. cents slow to accrue, that forecast is looking increasingly in doubt.

Whatever Poloz does, he needs to be clear about whether extraordinary measures such as negative rates or quantitative easing are closer to becoming a reality, Johnston says. The financial system could withstand rates as low as negative 0.5 percent, the governor said in a Dec. 8 speech that outlined the bank’s options as it approaches the so-called lower bound. Those measures aren’t required now, he said at the time.

“I will be more interested to see if the Monetary Policy Report itself talks more about the monetary strategy going forward,” Johnston said. “In an anxious environment like this the Bank of Canada is going to want to be seen to be doing something.”

For Johnston at Davis Rea and many others, it’s the speed of the bad news that makes more stimulus necessary.

“A month ago I would have said there really isn’t any big reason to cut rates,” Johnston said. “It’s clear, he should do something, to be seen to be doing something, and to be showing that they care.”

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