Today's CPI release has generated certain expectations (documented here, here, and I expect in pretty much every story covering the March inflation numbers) that a 50 bps cut in the overnight rate target is in the offing next Tuesday. Those expectations may very well be fulfilled - Mark Carney has been dropping broad hints ever since he announced his presence with authority that more interest rate cuts were on the way. But it's far from clear that another dramatic cut in interest rates could be justified. In fact, there's a much stronger argument for not cutting interest rates at all.
Let's deal with the inflation numbers first. Yes, y/y inflation is - by any measure - below the Bank's target. But this looks very much like a one-off level shift, not a change in the rate of inflation. What appears to have happened is that much of the long-delayed pass-through of the CAD appreciation happened all at once, and the trigger was the realisation that the CAD was trading at par with the USD. Even the most long-suffering, mathematically-challenged Canadian consumer was able to figure out that the price that she was paying was much higher than what her cousins to the south were, and a consumer revolt during the holiday shopping season led to a sudden drop in prices. And a very good thing, too.
But that's not the same thing as a drop in the growth rate of the price level. For the next few months, this one-off fall in prices will continue to show up as a reduction in y/y inflation, but once it's been fully incorporated - sometime towards the end of this year - y/y inflation will jump right back up again.
Now let's consider the effects of lower interest rates on aggregate demand, and in particular, its interest-rate-sensitive components:
- The housing market is doing just fine.
- So is non-residential construction.
- Fixed business investment intentions are looking good.
In the US, there's an awfully good case for trying to pump up the interest-rate-sensitive sectors of the economy. But Canada is not the United States; their problems are not ours, and we shouldn't be conducting monetary policy as if they were. These sectors are at or near capacity; they don't need further stimulus.
Moving on to the credit crunch. This is an exhaustively documented phenomenon in the US, but I'm unaware of a comparably clear-cut case for Canada. The best I've seen is from this speech by Deputy Governor David Longworth a couple of weeks ago, in which he presented this graph:
I'm not at all convinced that the lesson we should draw from this graph is that Canada is facing a credit crunch, and that the remedy is an expansionary monetary policy. These spreads have not shown up in the real economy (mortgage rates are lower than what they were before the subprime crisis hit), so the only thing I see is hard times for those who happen to work in the financial sector and whose livelihoods are directly affected by these spreads. It's probably not a coincidence that in the last two meetings of the CD Howe Monetary Policy Council, the private sector members' recommendations have been lower that those made by the academics. Or that bankers are anxious to put forward the notion that a 50 bps cut on Tuesday is somehow a slam-dunk.
I will not be overly distressed by a 25 bps cut. But if the Bank of Canada lowers its target for the overnight rate by 50 bps on Tuesday, it will be time to start talking about a 'Carney put'. And it will also be time for someone to make it clear to the Governor of the Bank of Canada that the instincts learned at an investment bank will not serve him well in his new job.
Maybe you could help me with this Stephen as I am not all that familiar with all the subtleties of credit but I don't get why the U.S. commercial and industrial loans do not seem to be impacted by the U.S. credit crunch. Why is that?
Posted by: JC | April 18, 2008 at 05:15 PM