Bank of Canada Cuts Rates, ECB Next to Move

January 21, 2015 Updated: April 24, 2016

January is turning out to be an extremely interesting month in terms of central bank activity. The question is: Do they inflate or deflate and why? The answer is: It depends.

The absolutely astounding move by the Swiss National Bank (SNB) to stop printing money and buying euros to defend the peg at 1.2 Swiss francs was deflationary. It pushes up the value of the franc and reduces the amount of money available in the economy. It also punishes exporters and the tourism industry because Swiss goods and services will become more expensive.

The Fed’s end of quantitative easing is also deflationary; it just stopped printing money and kept things as they are. Lo and behold the dollar has risen against virtually all other currencies.

Lower interest rates at least take away some cost pressure from the financing of hugely capital intensive energy projects.

China and Japan are always printing money, undervaluing their currencies and risking inflation. Now we have two new players in the inflation camp: The Bank of Canada (BOC) and the European Central Bank.

BOC Surprise

The BOC surprised everyone on Wednesday by cutting the main refinancing rate from 1 percent to 0.75 percent. This means banks have to pay less for their reserves at the BOC and also have more leeway to lend, an inflationary measure. As a result, the Canadian dollar cratered from $0.83 to $0.81

The BOC said low oil prices are deflationary and pose a risk to “financial stability.” Canada, a major oil producer, needs high oil prices for the more expensive oil sands projects to be viable.

Lower interest rates at least take away some cost pressure from the financing of hugely capital intensive energy projects, even though current projects won’t enjoy the lower rates until the next refinancing date.

As for other effects the move might have on markets, current BOC governor Stephen Poloz doesn’t care much, similar to his Swiss counterparts: “Market consequences will be what they are,” he said.

If energy goes down, the whole Canadian economy tanks. So a rate cut might stimulate all the sectors of the economy, if everything goes to according to plan.

Europe Needs a Different Caliber

While rate cuts might succeed in Canada, Europe needs a different kind of easing. After having talked about pretty much every option in the financial universe to boost its balance sheet, the bank tomorrow might finally announce a real quantitative easing program of $1.3 trillion dollars over two years.

Previously, unconditional buying of government bonds like the Fed has done in the United States wasn’t possible in Europe because the different member states could not agree on which assets to buy or which conditions to attach.

Once they agreed to buy asset backed securities for example, the banks would not sell it to them in the quantity they liked to buy. So now the last option left is to buy sovereign bonds of countries that are still issuing, which will mostly be France.

Germany is not going to issue any new debt this year and private participants are reluctant to see German bonds because they view them as a safe-haven security. France on the other hand still has large deficits but doesn’t have the crack-pot reputation Greece has for example, or it could be a mix of different bonds.  

If the ECB achieves its desired result of inflation across the continent, everybody from Spain to Germany will pay the price for it in the form of higher prices for consumer goods.

The BOC and the ECB are scared of deflation. However, have you ever heard somebody complain about lower prices?