The Bank of Canada cannot decide which way to go

The Bank of Canada cannot decide. They tightened monetary conditions by raising rates, most recently in July and September, sending the Loonie higher.  But this week they reversed course in dramatic fashion.

So which is the more likely path for interest rates in the next year? Higher or lower?

Following Wednesday’s announcement the Loonie traded a full cent lower against the US dollar. That move tells us that the announcement caught traders by surprise.

Source: Thomson ONE

It has been quite a roller coaster ride for the Loonie since May 3 when it closed below 73 cents, early September at 82 cents and now late October down to less than 78 cents. I wouldn’t be surprised to see the May lows retested before year-end. The strength since May wasn’t based on a solid foundation.

The BOC’s statements in July 12 and September 6 were unequivocal in their hawkish tone. To paraphrase it sounded something like: Rates must go higher because the Canadian economy is so strong.

In July: “Canada’s economy is robust, fueled by household spending,” the BOC said.

And on September 6:

“Recent economic data have been stronger than expected, supporting the Bank’s view that growth in Canada is becoming more broadly-based and self-sustaining. Consumer spending remains robust, underpinned by continued solid employment and income growth.”

I didn’t buy into their argument then because household debt growth is unsustainable and that’s where most of the buying power has been coming from.

But economists are trained to ignore debt and lending as those factors are not central to their economic models so the BOC focused on strong results from consumer spending.

But something happened between September 6 and October 25 and the Bank of Canada is now changing course:

On October 25:

Housing and consumption are forecast to slow in light of policy changes affecting housing markets and higher interest rates. Because of high debt levels, household spending is likely more sensitive to interest rates than in the past.”

All of this wavering between hot and cold is surprising because the BOC has been consistent in warning about two serious risks to the economy in every financial system review in the last few years. The latest in June 2017, was no exception:

Key Vulnerabilities in the Canadian Financial System


The most important vulnerabilities for the Canadian financial system in the judgment of Governing Council are interrelated:


  • elevated level of Canadian household indebtedness
  • imbalances in the Canadian housing market

Page 3 of Bank of Canada FSR June 2017.

On page 4 of the FSR the BOC continues to beat the drum saying,

“The vulnerability associated with household indebtedness has increased.”

So the people that write the Financial System Review are watching the changes in mortgage debt and consumer finance closely and they are worried that the rapid growth in consumer borrowing might cause a problem if anything goes wrong such as a recession, higher interest rates or changes in mortgage rules.

So the October 25 announcement fits with that view — that increasing interest rates could be dangerous given the dependence of the economy on consumers going deeper and deeper into debt. Or, as some people prefer — households accessing credit.

The final word to David Madani of Capital Economics:

Overall, the Bank’s policy statement sounded less hawkish … due to the worsening outlook for NAFTA, domestic housing risks and the potential increased sensitivity of heavily indebted households to higher interest rates…. (W)e expect the pace of economic growth to slow more than policymakers expect next year. If we are correct, then the Bank would presumably have no other choice but to reverse course. That isn’t something that markets are taking seriously at this stage, but they will be next year, with downside risks to the Canadian dollar.”

Capital Economics – Canada Update, October 25 2017


Hilliard MacBeth


-PDF version of this post-


The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinions and estimates constitute the author's judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them, having regard to their own particular circumstances.. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.