Taking a look at the Canadian dollar’s response to Wednesday’s Bank of Canada interest-rate growth, it is clear the market was surprised by how fast the central bank has jumped to this rate-hiking cycle. Investors might also be amazed by how fast the lender jumps back out.
Some pundits are saying that the speed increase — that was not anticipated until late October — has thrown open the door for impending additional rate hikes to come. This view is obviously shared by dealers in the currency, which jumped more than a complete cent against the U.S. dollar — a enormous one-day movement indicative of a significant change in market thinking.
Yet, besides making the speed increase a couple weeks sooner than many had anticipated, the bank’s statement accompanying its rate decision said precious little to encourage this hawkish view. In actuality, the Bank of Canada’s rate route might wind up looking much like the one the U.S. Federal Reserve has taken over the last two years: slow and halting, with substantial pauses between hikes.
If that’s true, then the lender has only established a communications challenge for itself. It might need to receive the market’s expectations back in the jar.
To be clear, pretty much everybody agrees that this rate increase was warranted. Statistics Canada reported last week that Canada’s gross domestic product grew at a leading 4.5-per-cent annualized rate in the second quarter, adding to an already strong run of growth in the previous three quarters. Given that the central bank had increased rates in July, which subsequent growth had far outpaced the bank’s prediction, another rate increase seemed like a lock.
The bank had indicated that it wanted to unwind the two rate cuts it made in 2015 to support the market through the oil shock, and had completed half of the job with its rate increase in July. The market was giving it an open invitation to complete that assignment.
Yet, prior to the rate announcement, the market saw it as no better than a coin toss whether the central bank would raise rates on Wednesday. The sticking point was one of the central bank’s communication practices: In summary, this was not the perfect rate announcement for the lender to explain its conclusion.
The Bank of Canada makes eight speed announcements annually. Four come with just a short written statement, as with Wednesday’s rate decision; another four also include the lender’s comprehensive quarterly Monetary Policy Report, complete with economic projections, and a press conference where the bank’s top officials can elaborate in their decision and address any misconceptions. The market has grown accustomed to the bank’s demonstrated inclination to book its speed moves to the latter dates, when a far more thorough feast of information is set out for investors’ consumption.
The central bank’s decision to raise rates today, rather than wait for another MPR-and-press-conference chance on Oct. 25, speaks to the shortcomings in the bank’s practice of just upgrading its economic outlook quarterly. Its predictions have been running behind the economic curve. To hold rates steady today and say, “We are taking a look at the economic indicators, we will inform you in our next quarterly update,” if it is blindingly evident that the market has trounced the bank’s expectations, would have been farcical.
Truly, Wednesday’s rate decision may have come in the strongest moment we’re likely to see in support of a rate increase. From the time the October announcement rolls around, the economic situation for additional hikes may already be weakening.
Everybody — including the Bank of Canada — considers the market will cool in the second half of this year. The export boom from earlier in the year has slowed considerably, perhaps associated with a rising Canadian dollar; exports face further headwinds since the money continues to climb. Inflation remains well below the lender’s official 2-per-cent goal, which can be problematic for a central bank whose rate policy is especially wedded to inflation targeting.
The Bank of Canada will want to determine how these two rate hikes perform with Canadian customers, whose willingness to invest has been a crucial part of the economic resurgence. (Over half of the next quarter’s GDP growth came from home consumption.) Record-high household debt levels, coupled with exceptionally low rates of interest where most of that money was borrowed, suggest that even modest rate rises pose an oversized drag on customer action.
Nevertheless, by increasing rates in the absence of more detailed communications, the markets have been left trying to fill in their own blanks regarding the central bank’s thinking. To make things worse, this rate increase comes after a long stretch since the last time any Bank of Canada official has given a public speech — that is fairly typical for the lender over the summer holiday period, yet exacerbates the shortage of fresh information accompanying this rate choice.
The Bank of Canada now has a pressing need to concentrate the next few weeks on clarifying its message — beginning with a Sept. 18 address from deputy governor Timothy Lane, followed by a speech by Governor Stephen Poloz the next week. Anticipate the lender to use those opportunities to remind markets that additional rate increases remain dependent on the financial data — and those statistics do not come anywhere close implying we have a steady diet of rate hikes coming.