Investors looking for insight on long-term interest rates can take their cue from ongoing central bank commentary.
The Bank of Canada offers “good insight” on where it aims to take its interest rate over the long run, says Patrick O’Toole, vice-president of global fixed income at CIBC Asset Management and co-manager of the Renaissance Canadian Bond Fund, an underlying fund in the Renaissance Optimal Income Portfolios.
In the central bank’s last monetary policy report, published in July, it said the neutral policy rate was estimated to be between 2.5% and 3.5%.
“The Bank is saying that should the economy continue to grow at trend, and should inflation continue to meet its target of about 2%, it expects to eventually take its interest rate to at least 2.5%,” O’Toole said in a late-August interview.
But keep in mind, he added, that the 2.5%-to-3.5% range is a long-run target, which “has been coming down for years, and we think it may still be a little bit high.”
The Bank of Canada’s rate should be roughly the same as its inflation target, O’Toole said. The inflation rate has been 2% on average for a decade, he added.
“If you get a bank rate above 2%, you’re actually paying investors a real rate of return,” he said.
“You shouldn’t get paid a premium when you’re not taking a risk on it.”
O’Toole estimates the neutral rate to be closer to 2% than the 2.5% to 3.5% the bank is estimating. The central bank’s guidance is “always subject to change,” he said.
At the annual economic policy symposium hosted by the Federal Reserve Bank of Kansas City in Jackson Hole last month, BoC Governor Stephen Poloz said the economic uncertainty resulting from digital disruption “means following a more gradual approach to normalizing interest rates than traditional models would advocate.”
O’Toole said the governor’s comments indicate “a stark realization that the main models [the BoC] uses to gauge the pace of the economy and the potential for inflation to accelerate beyond the bank’s target aren’t really calibrated for the new economy.”
That shouldn’t come as a surprise, O’Toole said. “Models are generally based on historical events, gauging how one variable has acted to impact another variable.” And with the digital revolution, which he called a “new variable thrown into the mix,” economic modelling is becoming difficult.
Overall, the governor’s statements indicate “the target is fluid,” said O’Toole.
This article is part of the AdvisorToGo program, powered by CIBC. It was written without input from the sponsor.