Back


Why the Bank of Canada Held Its Benchmark Rate

by Yvonne von Jena | January 21, 2016


The Bank of Canada Governor Stephen Poloz provided important insights into the deliberations of the Bank's Governing Council in determining its monetary policy and maintaining its benchmark interest rate at 0.5%. Here is a quick overview: Economic Projections In recent deliberations on various economies, it was the Bank's Governing Council’s judgment that:

  • The global economy remains positive, although cautiously so.
  • China will remain on its transition to a more balanced and sustainable growth path, despite the considerable attention paid to recent developments in China and the added to volatility it has caused in global financial and commodity markets. The Bank believes growth in China will fall from around 7% annual growth to around 6%,
  • The U.S. economy remains solid. Even though the fourth quarter of 2015 was soft, the Bank believes this to be largely temporary. Solid fundamentals, including strong employment gains, high consumer confidence and very strong investment outside the energy sector should see U.S. growth return to close to 2.5% in 2016.
  • The long-awaited economic turnaround in Canada will take longer than expected, due to low commodity prices and weaker demand in Canada’s non-resource exports. The Bank's new annual growth forecast for Canada in 2016 is 1.4%. The Bank noted that the Canadian economy appears to have stalled in the fourth quarter, mainly due to slower exports to the U.S. Importantly, much of this weakness was in Q4 2015 so fourth-quarter-over-fourth-quarter growth for 2016 is projected to be a more solid 1.9%.
Oil Prices, the Canadian Dollar and Inflation In its deliberations, the Bank’s Governing Council focused mainly on the implications of lower prices for oil and other commodities for Canada and for monetary policy. Two of these are:
  1. It may take up to three years for the full economic impact to be felt, and even longer for all of the structural adjustments to take place. Since October 2015, the magnitude of this shock has clearly grown, and the Bank had already built most of the downside into its models.
  2. The bigger change in its projection comes from the impact of even lower oil prices on Canadian income. As one measure of this change, the Bank's base case forecast suggests that it will now take longer to absorb the economy’s excess capacity—probably until late 2017, perhaps later.
The Bank’s most recent monetary policy report also suggested that increasingly low crude prices are pushing oil producers to the break-even point for company cash flows. If a significant number of firms were affected, the Bank said such a scenario would pose a potential threat to the broader economy. With respect to the Canadian dollar, the Bank now expects a 72-cent loonie for the foreseeable future. In October, the last time the bank put out its monetary policy report, that was 76 cents. The Bank also said household vulnerabilities have increased as a result of lower oil prices and dollar, but that the overall risks to financial stability have remained largely unchanged. Interest Rate Decision Rationale The Bank is holding its benchmark interest rate at 0.5% even as it downgrades its growth outlook for an economy hit by falling commodity prices. Some observers called for a rate cut on January 20th because of the magnitude of the oil-price shock. Others said the federal government’s promises to pump billions of dollars into infrastructure projects would be enough to keep Mr.  Poloz from moving the rate. Why did the Bank hold the rate firm? The main reasons that Mr. Poloz noted for holding the interest rate at 0.5% are:
  • Inflation has been unfolding as expected within its ideal target range.
  • The anticipated economic benefits from Ottawa’s commitment to spend on infrastructure. The Bank, however, said it did not factor in the potential positive impact of the measures because the details and the timing of the investments remain unknown.
Explains David Madani, an economist with Capital Economics, the Bank may be reluctant to give any more stimulus until the federal budget comes out. The Bank’s next rate announcement is scheduled for March 9.


Back