January 22, 2016 / 4:02 PM / 2 years ago

Bank of Canada may take back seat on stimulus as fx becomes a worry

OTTAWA, Jan 22 (Reuters) - When the Bank of Canada blinked in the face of its currency’s slide, wrong-footing many who had bet on an interest rate cut, it sowed some doubts about both its readiness and ability to help the struggling Canadian economy through some hard times.

Governor Stephen Poloz, offering a rare glimpse into the central bank’s debate, said on Wednesday policymakers initially leaned towards a cut, but cited the Canadian dollar’s slump and pending fiscal stimulus as factors that gave them pause.

For some analysts, that, combined with what they thought was Poloz’s too rosy economic outlook, suggested less room for policy maneuver, possibly limiting the central bank to a supporting role in efforts to bolster the struggling economy.

The acknowledgment of negative effects of the currency’s slide, which Poloz has repeatedly touted as a boon for Canada’s exporters and the economy at large, means that further easing could be less appealing or certain.

It also means that the ball is now in the court of the new government of Prime Minister Justin Trudeau and it is up to yet to be detailed spending plans to dispel fears that the commodity rout could drive the resource-rich economy back into recession.

“They’re admitting that they cannot do anything anymore and therefore fiscal policy will have to take the lead,” said CIBC Capital Markets Senior Economist Benjamin Tal.

While some economists welcomed that Poloz acknowledged for the first time widespread concerns about the pain the Canadian dollar’s drop to 12-year lows was inflicting on consumers, some were rankled by his downplaying of global economic and market headwinds.

“Ever since oil prices began to fall in 2014, the Bank of Canada seems to be suggesting that it’s temporary. They’re losing credibility, in my view,” said Sherry Cooper, chief economist at Dominion Lending Centres.

“These developments in the commodity market, oil in particular, are not temporary developments. This is a sea change, this is a massive structural shift.”

To be sure, some economists say with the overnight rate already at 0.5 percent, further cuts would not do that much to boost the economy while Canada’s exporters have yet to see the full benefits of the weak currency.

Poloz, 2-1/2 years into his seven-year term, is also facing different challenges than his predecessor Mark Carney, who now heads the Bank of England and earned praise and rock-star status for helping steer Canada through the global financial crisis relatively unscathed. But while a sound banking system and a commodities “supercycle” helped shield the economy back then, Poloz now has to deal with a collapse in commodity prices.


The central bank has been counting on non-oil exports, supported by a weaker Canadian dollar and U.S. strength, to offset the sharp pullback in investment in the energy sector caused by crude’s more than 70 percent slide from mid-2014 levels. However, with the energy industry also acting as a major source of demand for the manufacturing sector, some economists warn there could be more pain ahead.

“Hopefully the recent decline in the Canadian dollar will help the factory sector, but we know that energy is tied to manufacturing,” said Emanuella Enenajor, North America economist at Bank of America-Merrill Lynch.

“So the risk is that the factory sector will continue to struggle during this ‘transition period’, and the big risk here is that we won’t transition away from energy to manufacturing but that we’ll transition from energy to simply a stagnant economy.”

When asked about the argument that the central bank has effectively run out of tools to stimulate the economy, its spokeswoman pointed to Poloz’s speech in December where he outlined several unconventional tools it could still use, including negative rates or asset buying.

Even so, some economists argued those were emergency measures best kept on standby for times of truly deep distress such as the global financial crisis.

“The risks are still very acute in the global economy, they have very, very little monetary policy flexibility left and they need to be able to counter those risks if and when they really do accelerate,” said Derek Holt, economist at Scotiabank.

Since the release of the bank’s statement on Wednesday, the currency has risen more than 3 percent and markets pared back bets on further cuts, though they still price in about an 80 percent chance of a quarter point cut by mid-year.

Some economists said Poloz’s potentially biggest accomplishment was to reintroduce some uncertainty into the market, making the Canadian dollar less of a one-way bet.

“Ever since he’s started, he’s been seen as the person who wanted to drive the Canadian dollar down. It’s been seen as his agenda,” said Desjardins economic strategist Jimmy Jean.

The message on Wednesday was more balanced, he said. “It kind of sets some boundaries as to the level of tolerance that the bank has with respect to the currency’s depreciation.” (Reporting by Randall Palmer and Leah Schnurr; Editing by Tomasz Janowski)

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