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Bank of Canada Painted into a Corner

By Todd Hirsch Created: October 11, 2012 Last Updated: October 11, 2012
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There is little the Bank of Canada can do in the face of a high loonie and anemic GDP growth. (Matthew Little/The Epoch Times)

There is little the Bank of Canada can do in the face of a high loonie and anemic GDP growth. (Matthew Little/The Epoch Times)

A performance artist on Calgary’s Stephen Avenue mall turned heads and raised eyebrows this week. His project involved enclosing himself in a clear plastic cube for five full days with only water, a sleeping bag, a portable toilet, and lots and lots of paint. Over the course of the week, he has painted fantastic murals on the sides of his transparent home.

He is—in this case quite literally—painting himself into a corner.

External factors have tied the hands of the central bank.

Bank of Canada Governor Mark Carney may sympathize with this performance artist. As the chief monetary guru in the country (and particularly well-respected in central banking circles around the world), Carney and his Bank of Canada governing council colleagues make decisions that get attention. Their task is to head off inflation in the country by adjusting interest rates either higher (“tightening” in the jargon) to counteract rising inflation, or lower (“easing”) if inflation falls too low.

Currently, the Bank of Canada’s trend-setting overnight rate sits at 1.0 percent–a spot it has occupied without a break for more than two years. However, the Bank has always maintained what economists call a “tightening bias,” which means it consistently signals the monetary stimulus will eventually have to be removed and rates increased.

Like the Calgary performance artist, the Bank of Canada is painted into a corner. In its latest Fixed Announcement Date (Sept. 5), the Bank reiterated a familiar theme. “To the extent that the economic expansion continues and the current excess supply in the economy is gradually absorbed, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate . . .”

The tightening bias remains—albeit quite weak. Yet the Bank is unable and unwilling to raise rates at this point. Three main factors constrain it.

First, without a whiff of worrisome inflation in the Canadian economy, there’s been no reason for the Bank to raise rates. The target for overall consumer price inflation is 2.0 per cent, and the most recent reading is well below that (1.2 per cent in August). Even if food or energy prices started to climb and push inflation higher, the Bank would know it was because of global commodity price changes–not inflation caused by Canadians’ pent up consumer demand.

Secondly, the Canadian economy remains too fragile to sustain any kind of rate increase. Real GDP growth of only 1.8 percent in the second quarter came in below the Bank’s estimate. And despite the surprisingly strong jobs report for September, the labour market has been languishing. The unemployment rate in Ontario—which accounts for 40 percent of the national economy—remains close to 8 percent.

Finally—and perhaps most binding of all—the Bank of Canada is constrained by interest rates in the United States. There is nothing technically stopping our central bank from raising rates sooner or faster than the Federal Reserve. But if Canadian interest rates were to climb too far in advance of U.S. rates, it would push that little loonie higher, possibly to $0.10 or even $0.15 above parity with the U.S. greenback. That would not be acceptable—either to the government or the economy.

But unlike our brave and passionate street painter, the Bank of Canada was painted into its corner but not of its own choosing. External factors have tied the hands of the central bank.

And also unlike the painter, there is no precise time or date at which the Bank of Canada will find its way out of its corner. By 5 p.m. Friday, our street painter was flinging open the door of his beautifully painted cube and walking away (probably straight to a hot dog stand!)

But our central bank will remain in its cube for much, much longer. With the Fed holding rates at essentially zero until the middle of 2015, it could be well into 2014 at the earliest for the Bank of Canada to walk away from its 1.0 percent cube.

Troy Media Columnist Todd Hirsch is Senior Economist with ATB Financial. Article courtesy TroyMedia.com

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