Central Bank Idles as Economy Sputters
This morning, the Bank of Canada left interest rates unchanged. It should have cut interest rates because Canadaâ€™s slowing economy and overvalued currency are more serious problems than the spectre of inflation.
Last weekâ€™s Labour Force Survey indicated that Canada lost 39,000 full-time jobs in June, pushing unemployment to its highest level in nearly two years. Statistics Canadaâ€™s latest National Accounts show that real GDP declined rather than increasing in the first quarter of 2008.Â
The Bank of Canada itself acknowledges “excess supply” in the economy. It should have lowered interest rates to stimulate the business investment and consumer spending needed to mitigate this economic downturn.
The Canada-US Differential
The Bankâ€™s failure to reduce interest rates sufficiently has contributed to the excessively high Canada-US exchange rate. At the start of July 2007, central-bank rates were 5.25% in the US and 4.25% in Canada. Higher American interest rates gave international financiers some incentive to hold US dollars rather than Canadian dollars.
Today, central-bank rates are 2.00% in the US and 3.00% in Canada. Higher Canadian interest rates encourage international financiers to hold loonies instead of greenbacks.
Since July 2007,Â the Federal Reserve cut its target rate by 3.25% but the Bank of Canada cut its target rate by only 1.25%. To moderate the exchange rate, Canada must come closer to matching American interest-rate reductions.
Inflation Fears Exaggerated
The Bank of Canadaâ€™s unwillingness to cut interest rates, and calls for it to raise interest rates, are ostensibly motivated by concerns about inflation. However, the Bankâ€™s preferred measure, core inflation, is running at an annual rate of only 1.5%, well below the Bankâ€™s own 2% target.Â
Today, the central bank indicated, “Core inflation is projected to remain well contained and broadly in line with earlier expectations, averaging close to 1.5 per cent through the third quarter of this year and then rising to 2 per cent in the second half of 2009.”
Even the total Consumer Price Index, which includes gasoline and mortgage costs, has barely surpassed the 2%Â target. While rising commodity prices will increase the cost of some goods, Canadaâ€™s cooling real estate market will dampen mortgage costs.
The Bank should push Finance Canada to more meaningfully reign-in mortgage lending. Reasonable mortgage-insurance rules would be a better tool than interest rates to moderate inflation.