The day after the Bank of Canada raised its policy interest rate off its pandemic-emergency floor, the central bank’s Governor, Tiff Macklem, faced down worried questions about the strains rising borrowing costs were about to place on the backs of Canadians.
“The economy can handle higher interest rates,” he told the House of Commons finance committee Thursday.
“The economy can handle higher interest rates,” he told reporters in a news conference.
“The economy can handle it,” he said in a speech to the CFA Society of Toronto.
The fact that he repeated his response almost word for word throughout the day showed not only that he had prepared for the question, but that he wanted to be adamant in his answer. He sent an unequivocal message that he believes the Canadian economy is not only healthy enough to weather a series of rate increases over the next year, but will be healthier for it.
Mr. Macklem’s confidence is underpinned by the bank’s faith that the economy can pivot away from the bloated housing sector. It’s no given. The bank has tied its hopes to such a growth rotation before, and has been disappointed.
Last week’s gross domestic product report from Statistics Canada did, indeed, show economic strength: growth in the fourth quarter was at an annualized pace of 6.7 per cent, and the economy grew by 4.6 per cent in 2021 as a whole, lifting it above its prepandemic levels. The GDP data, combined with months of impressive employment numbers and widespread reports of labour shortages, are compelling evidence that the economy has reached full capacity. These are textbook conditions for a central bank to raise interest rates in order to keep a full-speed economy from racing ahead of itself.
But those GDP numbers also showed that investment in residential structures accounted for a quarter of the year’s growth – from a sector that makes up only about 8 per cent of the economy. The housing sector is also among the most sensitive to interest rates. The implication is that Bank of Canada rate hikes will apply the brakes to the economy’s growth engine particularly hard this time around.
Mr. Macklem indicated that the bank is counting on business investment and exports – both of which posted strong fourth quarters – to pick up the slack as rising rates inevitably weigh on housing momentum.
“There’s good reason to believe we’re going to see both stronger investment and stronger exports. That will broaden the recovery. That really is key to sustaining solid growth,” he said after the CFA speech.
That’s remarkably similar to the script embraced by Mr. Macklem’s predecessor, Stephen Poloz, as he attempted to guide the economy to a full recovery and return interest rates to normal levels during the lost decade after the 2008-2009 global financial crisis. Almost from the day Mr. Poloz started as governor in 2013, he talked optimistically about the economy pivoting from consumer-led growth fuelled by ultra-low-rate monetary policy and a soaring housing market, to a more “self-sustaining” phase driven by growing export demand that would spur businesses to spend on new equipment and expanded facilities. He often referred to this as bringing the economy “home.”
After a while, “home” was supplanted by a new catchphrase: “serial disappointment.” Mr. Poloz was forced to keep interest rates low for years as the economy lurched along, that elusive next phase of growth always just over the next hill.
Now, 2022 is not 2013. There are a lot of differences between the lingering after-effects of the global financial crisis that weighed on the world economy long after that recession had ended and the sudden shutdown and rapid (if incomplete) restart of the economy in the COVID-19 pandemic. Critically, strong policy actions taken both in Canada and abroad have been more effective in safeguarding the economy from more severe outcomes, and in lifting it back to its feet.
In fact, the current situation is almost the opposite of what we faced by 2013: we’re struggling with supply shortages as demand has raced ahead of current global capacity. The business case for investment is everywhere.
Still, the export growth and business investment Mr. Macklem is counting on have failed to materialize in the past when new sources of uncertainty have emerged, and it doesn’t take a major leap to see it happening again. The war in Ukraine poses a massive risk that could sideline demand and shake business confidence. The pandemic is still with us.
And if those other sources of growth stall, rising rates will pose an oversized burden on an economy that has relied heavily on debt-fuelled housing and consumer demand to keep it afloat.
“The fact of the matter is that we have a tremendously leveraged economy on our hands. It’s much more interest-rate sensitive than it has ever been in the past,” economist David Rosenberg, head of Toronto-based Rosenberg Research, told BNN Bloomberg last week. “That’s going to thwart the extent to which central banks can raise interest rates without crushing the economy.”
Your time is valuable. Have the Top Business Headlines newsletter conveniently delivered to your inbox in the morning or evening. Sign up today.