The Bank of Canada’s insistence that more interest rate increases are still needed has strategists fretting about policy mistakes.
Governor Stephen Poloz, speaking Wednesday in Ottawa, stuck to his view thatfurther hikes could still be in storeon the basis that an expected slowdown in economic growth, driven by slumping oil prices, will only be temporary.
Yet it was a different concern flagged by central bank officials that’s casting the most doubt on those plans: weaker-than-expected consumption and housing figures are adding to speculation past hikes have already gone too far.
“The Bank of Canada has hiked and will continue to hike into a more pronounced slowdown than the U.S.,” said Frances Donald, head of macroeconomic strategy at Manulife Asset Management. “It’s worth considering playing a policy mistake here in the bond market.”
The central bank’s five interest rate increases since 2017, as well as a variety of changes to mortgage rules from regulators and different levels of government, are taking a surprisingly large toll on housing.
Residential investment has subtracted from growth for three consecutive quarters. Home sales in the Toronto region fell 16 per cent in 2018, while in Vancouver they plunged 32 per cent. Recent weakness in oil prices, meanwhile, could have spillover effects on the real estate markets in energy producing regions.
The central bank revised down its expectations for the sector, which it now expects to shrink in 2019 after previously forecasting a small gain.
Softness in interest-rate sensitive segments of the economy goes beyond housing. Spending on durable goods also dragged on third quarter growth. Auto sales fell on an annual basis for the first time since 2009, and analysts expect another retreat in 2019. The Bank of Canada revised consumption down, and now projects it to add just 1 percentage point to growth this year, which would be its weakest contribution since the 2009 recession.
The Bank of Canada’s “entire chop” to projected 2019 growth — from 2.1 per cent to 1.7 per cent — is attributable to lower domestic demand, Bank of Montreal’s Chief Economist Douglas Porter said Wednesday.
All this talk of more rate increases suggests policy makers may not fully appreciate the impact they’re having on the economy, according to David Rosenberg, chief economist at Gluskin Sheff + Associates. “The bank has over-tightened as it is,” Rosenberg said Wednesday on BNN Bloomberg, adding he believes the hiking cycle has come to an end and it wouldn’t surprise him if the next move was a cut.
To be sure, the central bank is clearly aware of the issue, acknowledging Wednesday the economy may be more sensitive to higher rates than initially thought. It seems to be in no rush to hike, and it elevated developments in the nation’s housing market to one of the three key factors that will determine the pace of policy normalization after data showed it “slowed markedly.” That’s a shift from December, when Poloz described housing as “stabilizing.” It also stressed that any future move would be entirely data dependent.
Still, the Bank of Canada estimates neutral rates of interest are somewhere between 2.5 per cent to 3.5 per cent, which implies at least three more hikes from the current 1.75 per cent policy rate. But markets don’t see Poloz even getting within 50 basis points of the midpoint of that range within the next five years, according to the overnight index swaps curve.
There are too many unknowns about how the housing market will react to the cocktail of measures working to slow it down, said George Pearkes, chief macro strategist at Bespoke Investment Group.
“When it’s all combined with high prices at the same time, prudence is certainly warranted,” Pearkes said.
With assistance from Eric Lam