The Bank of Canada’s latest move is less surprising than you think

January 22, 2015

2-minute read

Canada’s financial industry and its associated analysts reacted with shock and dismay to the Bank of Canada’s announcement this week that it was lowering its trend-signalling interest rate from 1.0%, where it had been pegged since 2010, to 0.75%.

While they might have valid business reasons for their response – after all, virtually all of them had been advising their clients, employers, and shareholders that rates were likely to go up, not down, in the next few months, they shouldn’t have been surprised.

The gap between Canadian and U.S. interest rates created by the announcement should be widening. The U.S. economy is doing better than Canada’s and is likely to outperform Canada’s in the intermediate future. Low oil prices have less of a downside in the U.S. than they do in Canada, along with an equally powerful upside.

The Canadian dollar should be declining in value. It was grossly overvalued when its premium relative to the U.S. hit 10%. With the drop in oil prices below production costs in much of Western Canada, even a value in the high 80-90 cent range was excessive.

But there’s another reason why people shouldn’t be surprised that the Bank of Canada acted so decisively and so early to respond to clear signs of economic weakness.

Despite virtually universal agreement among the experts that monetary stimulus is pretty much tapped out as a response to weakening economic conditions, it is still – as it has been since the federal government embarked on its hell or high water deficit crusade – the only game in town.

Faced with evidence of economic weakness that couldn’t be clearer, federal fiscal policy – the only policy measure with any potential to stimulate the economy – is missing in action.

Just as the indicators of a weakening economy couldn’t be clearer, so, too, are the indicators that the federal government intends not just to sit this one out, but that it intends to persist with a fiscal strategy guaranteed to make the situation worse.

Despite the evidence that economic fundamentals have deteriorated, the government is sticking steadfastly, not only to its deficit elimination target, but also to the dangerously wasteful tax cuts that made the deficit reduction target harder to hit.

Remarkably, faced with a situation in which most responsible governments would have moved up its budget date in order to provide leadership and direction in troubling times – and to provide Canadians with assurance that the government is on the job and doing something to alleviate the impact of the oil crunch – the government is delaying the budget until April at the earliest.

The action by the Bank of Canada should be of concern to Canadians, but not for the reasons cited by the Canadian financial industry.

The bank’s decision on interest rates reflects its conclusion that the Government of Canada will persist with a policy trajectory that is bound to make the economy even weaker, despite evidence that should be guiding it in a different direction.

So while Canadians should be thankful that at least someone in power in Ottawa is paying attention to the real world, they might ask why it is the Bank of Canada, and not the government, that is doing so.

Economist Hugh Mackenzie is a CCPA Research Associate. Follow Hugh on Twitter @mackhugh

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