Interest rate call to come amid tough economy

Bank of Canada

OTTAWA – Regardless of the direction Stephen Poloz chooses, Wednesday’s closely watched decision on the Bank of Canada’s key interest rate will take place in front of an unsightly economic backdrop.

With oil prices in free fall, the global economy weakening and the prospects for Canadian growth dim, the central bank governor will reveal whether he intends to move the trend-setting rate.

It’s a question Poloz has had to face more than once as head of the bank: whether the strong medicine of cutting the already historically low benchmark is a necessary remedy for Canada’s ailing economy.

Poloz dropped the rate twice in 2015 to its current level of 0.5 per cent to help blunt the impact of sliding oil prices. The first of those moves — almost a year ago to the day — was a surprise adjustment that blindsided markets.

This time around, observers are divided on whether he will pull the trigger again — and whether he should.

Desjardins senior economist Jimmy Jean falls into the camp of analysts who expect Poloz to stand pat — and said he believes he’d be wise to do so.

This year, Poloz must once again consider falling oil prices, a weakening dollar and inflation at the lower end of the bank’s one- to two-per-cent target range.

But things have also changed over the last 12 months, Jean said as he explained why he thinks Poloz should avoid using the primary tool in the central bank’s kit.

The new Liberal government has pledged to stimulate the economy with deficit-fuelled infrastructure spending. Last year, the previous government was heading into an election striving to produce a balanced budget.

Jean said he believes those spending plans are sufficiently substantial to keep Poloz on the sidelines.

But he doesn’t expect Ottawa’s commitments, which also include a revamped child-benefits program and tax-bracket changes, to shield the economy from a rough ride in 2016 and 2017.

“Those policies will help, but we have to face the fact that we’re going to suffer for a while,” Jean said.

“There’s no way to really, fully offset that pain.”

Earlier this month, Poloz spoke of the bumpy road ahead as he warned that the forces uncorked by the oil-price shock “simply must work themselves out.”

Poloz’s comments led some to believe he would leave the rate untouched. But economic conditions, including oil prices, have continued to deteriorate since the speech, only a couple of weeks ago.

In the last week, many analysts have changed their positions and now believe Poloz will cut rates.

Emanuella Enenajor, senior economist for Bank of America Merrill Lynch Global Research, is predicting a rate cut of 0.25 per cent and a projection for 2016 real gross domestic product that gets trimmed to 1.5 per cent, from two per cent.

“In our view, this is a shock substantial enough to warrant another easing,” the firm wrote in a note to clients Tuesday that also speculated Poloz may be forced into action a second time this year.

“If energy prices remain persistently low, one rate cut will not likely be enough to stimulate the economy back to a reasonable growth path.”

Experts, including the International Monetary Fund, have downgraded their growth projections for Canada. The IMF dropped its 2017 forecast Tuesday to 2.1 per cent, from 2.4 per cent in October.

Canada’s commodity-dependent economy has been walloped by falling prices — particularly in Alberta, where bond rating agency Moody’s changed the outlook to negative from stable while retaining the province’s triple-A rating.

A new report by the International Energy Agency warned that world oil prices could fall further because markets could drown in over-supply — particularly as sanctions are lifted on Iran amid pessimism about the prospects of global demand.

Lower oil prices, meanwhile, have also helped drag down the dollar.

While the weaker loonie has some negative effects, such as driving up prices on some consumer products and the cost of travel to the United States, experts say it provides benefits for the economy overall.

Poloz has described the flexible exchange rate, which tightly tracks the ups and downs of crude prices, as one of the “minor shock absorbers” that help limit the fallout for some segments of the economy.