Bank of Canada Holds at 3% Yet Again
For a third consecutive announcement, the central bankâ€™s communications department reused the headline, “Bank of Canada keeps overnight rate target at 3 per cent.” This repetition implies that central bankers have not perceived a fundamental shift in the balance of factors considered since they last changed interest rates four and a half months ago.
In fact, much has changed in just the seven weeks since the Bank of Canadaâ€™s last interest-rate announcement (July 15). The need for economic stimulus has become more pressing and the capacity of monetary policy to control inflation has diminished. Therefore, the central bank should have decisively cut interest rates today.
The most recent Labour Force Survey release (August 8 ) revealed that Canadaâ€™s private sector eliminated 95,000 jobs in July. This employment news is the worst reported since the recession of the early 1990s. Last weekâ€™s Gross Domestic Product figures revealed that the Canadian economy is smaller now than it was at the end of last year. In the second quarter of this year, our economy grew at a pitiful annualized pace of 0.3% whereas the US economy grew at an annualized pace of 3.3%.
Many factors could help explain why Canada is now underperforming the US, but one may be that the Bank of Canada has provided less than half as much economic stimulus as the American Federal Reserve. Over the past year, the Fed cut target interest rates by 3.25% (from 5.25% to 2.00%). By the comparison, the Bank of Canada lowered target interest rates by only 1.50% (from 4.50% to 3.00%).
Although the Canada-US exchange rate has eased somewhat in recent months, the fact that interest rates are a full percentage point higher in Canada is still helping to hold the loonie significantly higher than warranted by purchasing power parity or other measures.
The last Consumer Price Index release (August 21) provided little justification for maintaining interest rates in an effort to control inflation. Many commentators had argued that the Bank needs to raise or maintain interest rates to quell inflation in western Canada, despite the pressing need for economic stimulus in central and eastern Canada. For many months, inflation had exceeded 2% only in Alberta and Saskatchewan.
The August 21 figures show inflation much more evenly spread across the country. From June to July 2008, consumer prices actually fell in Alberta and Saskatchewan, bringing annual inflation in these provinces into line with the national average. The changing regional distribution of inflation reflects changing causes of inflation.
When Canadian inflation was concentrated in Alberta and Saskatchewan, it could reasonably be attributed to economic booms in these provinces. Economists generally believe that central banks can limit this type of “demand-pull” inflation through higher interest rates.
Now that inflation is evenly spread across Canada, it cannot be attributed to a regional economic boom. Instead, consumer prices were higher everywhere because global commodity prices were higher. Economists generally agree that central banks cannot control this type of “cost-push” inflation. Certainly, Bank of Canada interest rates have no meaningful effect on the prices of gasoline, food and other global commodities.
In any case, these prices are now trending downward. The Bank of Canadaâ€™s last rate announcement (July 15) occurred just after oil had reached $147 per barrel. Today, oil is trading below $110 per barrel. Therefore, commodity-driven inflation seems likely to ease. Core inflation has remained at only 1.5% for four months. These developments should have prompted the Bank of Canada to cut interest rates to provide much-needed economic stimulus.