Bank of Canada Governor Stephen Poloz said the need to buffer the economic harm from the novel coronavirus outweighs the risk that lower interest rates could deepen Canada’s household debt problems, as the central bank scrambles to “get out ahead” of a feared consumer-led slump.
In his first public comments since the bank slashed its key lending rate by a half a percentage point on Wednesday, Mr. Poloz told a Toronto business audience that the anticipated downturn caused by the virus would likely mute the stimulative impact of the deep rate cut on housing demand and consumer debt.
He said the bank believes the most “profound” effect on the Canadian economy from the virus will be its damage to consumer confidence and the resulting loss of demand, arguing that lower interest rates would help cushion the impact on consumers.
“Governing council [the bank’s rate-setting body] agreed that the downside risks to the economy today are more than sufficient to outweigh our continuing concern about [debt-related] financial vulnerabilities,” he said. “Indeed, declining consumer confidence would naturally lead to reduced activity in the housing market. So in this context, lower interest rates will actually help to stabilize the housing market, rather than contribute to froth.”
Speaking with reporters after his speech, Mr. Poloz indicated that the governing council had been leaning toward a quarter-point rate cut anyway, given evidence that Canada’s tepid fourth quarter and likely slow first quarter weren’t merely products of temporary disruptions such as weather, strikes and rail blockades, but rather reflected “structural” economic weakness.
The rapid escalation of coronavirus and COVID-19 fears, which now threaten second-quarter growth, convinced the bank’s officials that they needed an even bigger cut – the biggest since the 2008-09 financial crisis – rather than wait for the outbreak to start imposing further weight on Canadian economic indicators.
“We think it’s important, if possible, to get out in front," Mr. Poloz said. “We’re hopeful … that by being clear and decisive, and moving in a significant way, that we get a behavioural response that cushions the economy before the real part of the coronavirus [economic] effect arrives.”
“We made a decision this week not to dip our toe in the water," he said. "We believe we’ve done a lot there to cushion the blow. We don’t know how big the blow might be.”
The Bank of Canada reduced its rate a day after the U.S. Federal Reserve announced a cut of the same size. Finance ministers and central bankers of the Group of Seven pledged co-ordinated action this week to support the global economy as the virus spreads.
Mr. Poloz described the degree of co-ordination among G7 policy makers as “the highest I’ve seen” in his nearly seven years as governor.
“We all have a shared understanding of the impacts, we have a shared understanding of what tools we’ve got and when we would use them,” he told the audience. "Those lines are wide open, and we’re talking basically every day now.”
But Mr. Poloz indicated the Bank of Canada was already headed toward its half-point cut even before the Fed’s announcement.
“I’m not saying it didn’t matter, it mattered to us, of course,” he told reporters. "When you have policy making, if it’s a global shock, when it’s co-ordinated you get an outsized reaction, because it’s more confidence-inspiring when other entities are doing the same thing. … So to us, that was also a positive benefit to the fact that the Fed went on Tuesday and we knew we were going the next day.”
After the Bank of Canada cut its overnight lending rate to 1.25 per cent from 1.75 per cent Wednesday, Canada’s major banks followed by reducing their prime lending rates to 3.45 per cent from 3.95 per cent. Bank of Montreal chief economist Doug Porter said this week the rate cuts “will put housing on steroids.”
Interest rate cuts are aimed at spurring economic activity through increased borrowing. However, the bank has long identified high household debt levels as a concern.
But Canadian Imperial Bank of Commerce economist Benjamin Tal noted that borrowing costs were already low prior to the rate cut, yet consumer appetite for new debt has softened of late.
“I think the uncertainty related to what’s happening in the economy as a whole will prevent [consumers] from getting too much [debt]," he said. "That’s why I think the impact on real estate will not be huge. It will be strong, but it will not be overwhelming.”
Mr. Poloz said it is uncertain how much economic harm the virus will cause. Disruptions in China, where the virus first appeared, are having ripple effects on global supply chains. Travel-related sectors are seeing the immediate consequences, as businesses and tourists cancel trips.
“A lot has happened in the past six weeks,” Mr. Poloz said. “In particular, the global economy will, at the very least, be significantly disrupted by COVID-19 in the first half of the year. It’s possible that the global economy will snap back quickly after health professionals have managed the situation and conditions have returned to normal.
“However, the outbreak and its effects could be more persistent. Consumer and business confidence could be set back for a longer period of time, causing economic growth to slow more persistently. This could include longer-term layoffs, for example. At this point, we simply do not know.”
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