Poloz’s Rate Cut the Wrong Move at the Wrong Time


By Paul Gardner – this article appears in the Globe and Mail

Now that we have absorbed the initial shock of the Bank of Canada rate cut and the subsequent meeting, we can try to begin to understand the logic behind it.

When we look at recent monetary policy around the globe, there appears to have been a competition between many countries to devalue their own currency as the main mechanism to stimulate the growth of their own economy at the expense of others. The term beggar thy neighbour is often used to explain this global phenomenon.

Up until January of this year, the Bank of Canada’s usual method of relaying monetary information was through a defined, transparent process that was familiar to the market. The central bank had spent more than a decade nurturing this transparency, especially under Mark Carney’s tenure. This measured process was abandoned on Jan. 21 with a shocking rate cut. As we know, most analysts were expecting a gradual rise in the overnight banking rate over the next several months. But due to the collapse of oil prices, combined with other countries cutting their rates, the Bank of Canada felt obliged to reduce our rate as well.

Why was this cut necessary? The Bank of Canada followed all the global banks by aggressively reducing the rate in the 2008-09 period to offset the financial crisis from what has now been termed the Great Recession, with the result that we have had historic low rates for the past four years already. The Canadian economy has been growing at around 2.25 per cent. Not a booming economy, perhaps, but still growing at a satisfactory rate. Although employment growth has slowed, it is still positive; new jobs in Ontario and Quebec should help offset Alberta job losses over the next few years.

Before the rate cut, the loonie had depreciated compared with the U.S. dollar by 10 per cent, which again should help the manufacturing provinces. The bank and economists argue that it takes roughly one to two years for a depreciated currency to take effect. The Canadian economy has yet to show any effects from the dollar weakness.

Possibly as early as this June, the U.S. Federal Reserve will start the process of raising its federal funds rate. This course of action should continue throughout next fall. Why is the Bank of Canada going in the opposite direction?

More importantly, the rate cut will only further fuel the overextended housing rally and private debt consumption. Over the past several years, the Bank of Canada has been obsessed with lowering consumer debt accumulation. The rate cut goes completely against this astute strategy and blatantly encourages more consumer debt. Even so-called rational financial advisers are saying now is the time to invest or spend since loans are so cheap, instead of retiring debt, because the message received from the Bank of Canada is that it is healthy to stimulate more debt acquisition. It is not.

Over the past decade, both the government and the Bank of Canada have tried to nourish productivity, which increases a country’s wealth. The weak dollar policy that the Bank of Canada has now adopted only makes productivity more difficult to achieve since it will be much more expensive to import equipment and technology. A dynamic economy needs to create highly skilled technological jobs or high-end processing in the manufacturing base. Disappointingly, this will not occur.

Canada’s economy had the ability to survive and overcome the weakness from the oil sector. As a country, we would have been fine “sitting” with an 85- to 90-cent (U.S.) dollar. But the Bank of Canada panicked and misguidedly copied the tactics of Europe. However, the European countries that cut their rates have home currencies that were getting stronger compared with their main trading partner, not weaker, such as in Canada.

A few years ago when Stephen Poloz took over as Governor of the Bank of Canada, he alluded that the hardest job for the central bank chief is to “sit on one’s hands and do nothing.” He would have been wise to remember this since the Bank of Canada would have served Canada better by doing nothing. It appears that Mr. Poloz is still behaving as the ex-CEO of Export Development Canada (EDC), which required a very different set of actions. He needs to start being the Governor of the Bank of Canada.