Poloz Has a Freer Hand on Rates as Morneau Fills Wish List

Updated on
  • BoC Governor has said housing and debt are major risks
  • Federal government unveiled sweeping mortgage changes Monday

Bank of Canada Governor Stephen Poloz has more leeway to cut interest rates again if the long recovery from an oil bust falters, now that Finance Minister Bill Morneau has stepped in to tackle a housing boom.

In measures unveiled Monday in Toronto, Morneau tightened rules on mortgage lending -- the latest step in a years-long effort by officials to rein in escalating home prices. Families in Vancouver and Toronto are amassing record debts as they struggle to buy into a market where bidding wars on million-dollar homes are now common.

The housing boom, fueled by historically low interest rates, constrained the Bank of Canada’s ability to counter any further slowdown in the economy. Cutting rates further would in theory make borrowing more attractive, fueling the fire.

“They would like to see a slowing in the housing investment activity in Toronto and Vancouver,” David Doyle, an analyst at Macquarie Group Ltd. said in a Bloomberg TV Canada interview Monday. “That would remove one significant barrier for them to cut rates.”

The Bank of Canada identifies household debt as one of the top risks to the country’s financial system. However Poloz has said in recent speeches it will be the job of other policy makers to counter those risks, because the central bank’s primary task is to target inflation. Poloz cut his key lending rate twice last year to 0.5 percent to keep the economy out of recession as oil prices fell below $50 a barrel.

Growth Rebound

It’s still too soon to talk about rate cuts. Poloz has predicted growth rebounding to a 3.5 percent annualized pace in the third quarter after Alberta wildfires in May caused a 1.6 percent decline in the second. Gross domestic product expanded 0.5 percent in July as Alberta’s heavy oil production rebounded.

Swaps trading suggests bets on a cut have actually decreased slightly since the Monday announcement. Odds of lower rates by the end of 2017 stood at about 22 percent Wednesday, versus 33 percent at the end of last week.

Bank of Canada Senior Deputy Governor Carolyn Wilkins is due to deliver remarks on Thursday in Trois-Rivières, Quebec on economic trends and monetary policy. The central bank’s next rate decision is scheduled for Oct. 19.

‘More Leeway’

“There is a case for more easing, but there is an even more important case for keeping the current status quo,” said Thomas Costerg, senior economist at Standard Chartered Bank in New York. The housing measures in theory mean “more leeway to cut rates,” he said, adding a weak economy means “the BoC cuts rates down the road.”

Doyle, who sees a 30 percent chance of a cut by the end of next year, says a potential trigger for a rate cut could be persistently low inflation.

Canada’s core rate of inflation receded to 1.8 percent in August, the slowest pace in two years, potentially underscoring broader weakness in the economy.

Morneau’s housing moves followed several previous rounds of tightening that did little to curb a price surge in Vancouver and Toronto, and a continued upward march in household leverage. Consumer debt last month exceeded GDP for the first time.

The new measures will have more of an impact, according to National Bank Financial strategist Stuart Kraft, who predicts the moves could slow the pace of economic growth to below 1 percent.

Still, it’s still too soon for Poloz to come back in with a rate cut, according to Derek Holt, Scotiabank’s vice-president of economics in Toronto. “If they cut again, then a significant part of the recent tightening of mortgage rules would be negated,” Holt said. “Monetary policy and regulatory policy would be at loggerheads.”

— With assistance by Allison McNeely

(Updates with estimated growth slowdown in 13th paragraph.)
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