Some experts see peril in call for higher interest rates
Published Monday, July 19, 2010 8:09PM EDT
OTTAWA - Bank of Canada governor Mark Carney has seldom heard such unanimity about what he should do with interest rates at a time of economic uncertainty.
The consensus of 12 economists surveyed is that the governor will hike the policy rate by a quarter point for the second time in as many months Tuesday to 0.75 per cent, still an extremely low level.
It's the same verdict for the 11 private sector and academic analysts who made up the C.D. Howe Institute's monetary policy council this month -- all casting their vote for further rate increases. Four even called for a half-point jump to one per cent.
As well, the markets have priced in a quarter-point hike for weeks.
But a few bearish economists are urging Carney to ignore the dubious wisdom of crowds, warning of potential danger if he succumbs to the pressure to raise borrowing costs as the economy is starting to recover from recession.
"I don't believe the case for hiking rates is valid, and I think Canada will pay for this," says Carl Weinberg, chief economist with U.S.-based High Frequency Economics.
Higher interest rates drive the cost of borrowing higher, discouraging consumer spending and business investment that are key to economic growth. As well, Canada will open up a three-quarter point interest rate differential with the U.S., which will raise the value of the loonie and squeeze Canadian exports to the United States.
"You could push the economy back down into the hole again," Weinberg warns.
Brian Bethune of IHS Global Insight concurs, saying Carney's first mistake was to signal a leaning towards higher rates in April, then following through with the first rate hike in three years on June 1.
The result was that markets pushed up mortgage rates in the spring by a full point percentage point, helping to kill off the housing rally, which had been a key driver of Canadian growth.
Carney himself appeared to express some reticence last month, noting that the global recovery was uneven and in advanced economies, "heavily dependent" on government and central bank stimulus. He wrapped up by cautioning against counting on a second hike on July 20, as many had and still do.
"Given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments," he advised.
Since, almost all indicators have gone south. Along with the European debt worries is concern that the U.S. may be heading toward a double-dip recession. China has advised its growth will be more moderate going forward.
In Canada, the economy followed an extraordinary 6.1 per cent acceleration in the first quarter with a sudden thud in April -- no growth. Retail sales, housing, manufacturing and balance of trade have all turned negative.
The argument for further interest rate hikes, as expressed by the C.D. Howe panel, was that the need for so-called emergency-level rates had ceased and that financial-market indicators point to inflation above two per cent -- the central bank's target -- in the next few years.
Royal Bank chief economist Craig Wright, who is a member of the panel, said the bears are exaggerating the impact of modest rate increases from what are unsustainably low rates.
He points out that Canada had the best two months of job creation on record in April and June, when employment grew by 109,000 and 93,000 respectively.
"The crisis has eased, and in that environment the crisis setting for both interest rates and fiscal policy can be eased as well," he argued. "The Bank of Canada is not looking at inflation today, it's trying to extrapolate where it will be in 12 to 18 months and if we don't moderate growth, we will run into inflationary concerns."
Wright does agree with the bears that this is no time to be aggressively tightening policy.
But labour economist Erin Weir of the United Steelworkers says any increase, even a small one, is without basis.
While 372,000 new jobs were created during the past year as of June, 270,000 more people joined the labour force during that period, he notes. This explains why the unemployment rate remains relatively high at 7.9 per cent, two points higher than it was before the recession.
And Bethune calls inflation a bogeyman. It is currently a tame 1.4 per cent, and with the global economy braking, unlikely to rear its head any time soon.
Bethune suggests an almost psychological fear of low rates may be behind the push to raise them. He reflects back to the summer of 2008, a few months before the economy caved in, when the consensus was near unanimous that rates were still too low. The concern looks absurd now.
"They are discomfited, they get twitchy, their feet are jumping because rates are too low," he says of monetary economists.
"Even in the Fed (U.S.'s central bank), there was an emerging consensus early in 2010 that it would have to have an exit strategy and start implementing it within months ... and now look where we are." Last week, the Fed was considering further stimulus as it downgraded American's economic outlook.
Bethune says Carney should look past the temporary strong jobs numbers and already past first quarter growth, and instead focus on the weak U.S. recovery and the drag it is bound to have on Canada going forward.
"It would be hard for them (Bank of Canada) not to raise rates when there are so many people saying raise rates, but this is when the central bankers earn their money," he said.