Upward path for interest rates ‘highly uncertain’: Bank of Canada governor

The country’s road to higher interest rates is “highly uncertain” as the Bank of Canada monitors evolving unknowns related to indebted Canadians, stricter mortgage rules, business investment and global trade, governor Stephen Poloz said Thursday.

In a speech in Montreal, Poloz said he expected the benchmark rate to eventually rise above its current level of 1.75%, but how long it takes to get to its likely destination of between 2.5% and 3.5% is the part that remains to be seen. The destination is also referred to as the bank’s neutral range.

“As we said at the bank’s most recent interest rate announcement, we judge that we will need to move our policy rate up into a neutral range over time, to a point where it is not stimulating or constraining economic growth,” Poloz told the Chamber of Commerce of Metropolitan Montreal.

“However, the path back to that neutral range is highly uncertain. We will watch the data as they come in, and use judgment to deal with the uncertainties and manage the associated risks.”

The bank’s neutral range is an estimate of the preferred level for the interest rate when the economy is operating at full capacity and when inflation is within its target zone of 1% to 3%.

For now, Poloz noted that the rate is low enough, at its below-inflation level of 1.75%, that it’s continuing to deliver stimulative effects to the economy. Statistics Canada’s December inflation reading was 2%.

Poloz said the central bank will scrutinize incoming data to watch how several important uncertainties unfold.

They include, he added, the evolution of the impact of higher interest rates on indebted Canadians, how housing markets adjust to higher borrowing costs and stricter mortgage guidelines, whether business investment picks up its pace and the “highly uncertain” global trade environment.

The improved economy has encouraged the bank to raise its key interest rate five times since mid-2017 to keep inflation from creeping up too high—but it hasn’t introduced an increase since last October.

“We’ve been at the same interest rate since last October precisely because the data have been giving us some mixed messages,” he told reporters following his speech.

“As we’ve said over and over, we’re data-dependent. So, it depends on how the economy delivers.”

Poloz has said the central bank will likely continue hiking rates once the economy builds new momentum following a soft patch largely caused by unexpectedly weak oil prices in late 2018.

He made a point Thursday of saying that Canada’s labour market remains “extremely strong” and wages are showing improvement outside of oil-producing provinces. Business sentiment indicators have also been encouraging, he said.

The bank’s next interest-rate announcement is March 6—and many market watchers expect Poloz to leave the benchmark untouched until late this year.

The governor’s speech also walked the audience through the power and the limitations of the bank’s main policy tool: the key interest rate target.

He shared an example on what would have likely happened if the bank hadn’t introduced five quarter-point increases to bring the rate up to 1.75%.

“If we had kept our interest rate at 0.5% from mid-2015 until now, our models tell us that we would have seen stronger economic growth—no surprise there,” Poloz said.

“By now, the level of [the growth domestic product] would be about 2% higher than it is today.”

However, he added that while such an increase may sound good, it would have pushed inflation to the top of the bank’s inflation range, and likely even higher.

The bank would have then been compelled to raise rates “forcefully” to guide inflation back to its target over the next year or two, Poloz said.

With lower rates over a longer period, he added every Canadian would have likely amassed about $2,000 more in additional debt.