A Very Defensive Bank of Canada Governor Takes Issue with His Critics

Several critics, including this author[1], have taken issue with the Bank of Canada signaling that the bank rate should continue to rise to 3 percent from its current level of 1.75 percent.  The Governor makes the argument that economic growth is ‘solid’, thus allowing for further tightening. Critics, on the other hand, dismiss the Bank’s rather ‘rosy’ outlook for Canada[2]. They point to the IMF’s downgrading of global growth and trade; the slowdown in China; the slump in financial markets in North America; and, in Canada where both employment and wages are stagnating. The Governor answers his critics by trying to reconcile the Bank’s latest outlook to recent developments in the financial markets.

In a recent speech,[3]  Governor Poloz offers a brief lesson on how the financial markets are operating in response to recent policy moves by central banks to tighten lending conditions. He argues the Bank’s views about the risks facing the global economy are consistent with risks experienced in the financial markets.  In a nutshell, the Governor maintains that risks facing investors are balanced and as such the Bank could adopt a more hawkish position regarding interest rates.

Every central banker has long wanted to see higher long-term rates and an upward sloping yield curve as a sign that the economy is healthy and growing. However, the actions of the central banks are making more difficult to maintain a healthy economy. The Federal Reserve is not only raising rates but is shrinking its balance sheet and thus soaking up liquidity worldwide. The withdrawal of liquidity is putting a great deal of stress on markets both domestically and internationally. As mortgage-backed -securities are cashed in by the Fed, the US mortgage industry is looking at higher rates and considerable pressure on housing. Internationally, the emerging markets must grapple with a stronger US dollar and capital outflows in response to US interest rate hikes.