Bank of Canada Governor Stephen Poloz will give a speech in Toronto on Thursday. Remarks will be available at 12:40 p.m. The speech will be followed by a press conference at 13:45 p.m. The topic is “Issues keeping the governor awake at night.”
For a central banker pursing a 2% inflation target, one of these issues in our view is the low inflation environment still in place despite the accelerating, and synchronized, global economic cycle. The Canadian economic recovery has been very strong this year. Yet, core inflation figures registered in recent months are the same as a year ago (at 1.6%, see chart). Globalization and digitalization were mentioned in the October MPR as structural factors dampening the Canadian CPI. These factors could also boost Canada’s production capacities above traditional estimates of potential output, sufficient to maintain a solid-GDP growth path and a low-CPI inflation environment for quite some time.
Another issue is the absence of a broad-based improvement in labour market conditions that, in turn, is restraining inflationary pressures. Granted, full-time employment is booming (up 3% year-over-year), the unemployment rate plunged to a 10-year low (5.9% in November) and the hourly wage of employees has been accelerating (2.7% year-over-year in November). However, the total number of hours worked by Canadians only increased by 1% year-over-year, unit labour costs are up only 1% and long-term unemployment remains high (about 20% of the total unemployed). Under these circumstances, it is difficult for us to forecast three or four policy rate hikes in 2018.
The trouble resulting from lower interest rates is high indebtedness and inflated asset prices, particularly in the housing sector. These vulnerabilities were highlighted again in the BoC Financial System Review released in late November. The good news is that the Canadian housing market is going through an adjustment phase following new regulatory and regional housing policies. For instance, housing market conditions in the GTA have been cooling down in 2017 following the introduction of new rules on housing by the Ontario government (see chart below). In January 2018, the new stress test for borrowers with conventional mortgage loans is expected to further improve the quality of mortgages. In February 2018, the provincial government in British Columbia is also expected to announce new housing policies to improve housing availability and affordability. Altogether, these targeted measures imply that next year, the BoC can focus on the inflation dynamics within the broader economic cycle, rather than on removing monetary stimulus to prevent excessive financial leverage.
Finally, one big issue is the uncertainty surrounding the NAFTA negotiations. NAFTA termination still remains a non-negligible possibility, following U.S. President Donald Trump’s remarks in Florida last weekend. Under such a potential scenario, the course of adjustment for the Canadian export sector could depend, among other things, on the BoC’s monetary response, the federal government’s fiscal policies and the magnitude of the CAD depreciation. For one thing, would he need to, the current murky trade outlook is currently preventing Poloz from expressing a stronger preference for higher interest rates.
Bottom Line: The monetary policy tightening cycle which the BoC entered in 2017 will not be a smooth ride. The BoC already took a pause to reflect on the weak inflation outlook after hiking in back-to-back policy decisions last summer. Some of the “Issues keeping the governor awake at night” could be resolved in 2018. Yet, others could come up as well. This makes it a challenging time to make monetary policy decisions for the economic well-being of Canadians.
