Canada Floats Negative Rates

Market Trends - 09/12/2015

In spite of the tremendous headwinds facing the Canadian economy, Bank of Canada Governor Stephen Poloz sounded upbeat and optimistic in his assessment of the economy and the outlook. In his comments, Poloz pointed out that Canada is not necessary facing down a recession but rather a mild contraction. Supportive monetary policies have managed to insulate the economy from further losses and the Central Bank is not far from hitting its inflation target of 2.00%, corroborated in large part by headline CPI currently trending at a 1.00% annualized pace. According to the latest forecasts, inflation is expected to rise back towards the 2.00% goal around the middle of 2017 as long as moderate growth in the economy persists, echoing forward-looking projections delivered from other major global central banks. However, there are a number of factors that could potentially derail these estimates. Increasing signs of weakness from China’s latest data combined with the parallel drop in oil prices after OPEC’s inconclusive meeting combined have raised concerns about the outlook for the broader Canadian economy.

While the Bank of Canada contends that it is well prepared for any further contingencies regarding another financial crisis with plans set up such as charging banks for deposits and asset purchases, these nontraditional measures may raise a few eyebrows. More disconcerting was Governor Poloz’s remarks on the effective lower bound for interest rates. After studying the aftermath from the move to negative rates by the European Central Bank and the Swiss National Bank, the Bank of Canada is quite confident that the economy could survive a negative rate environment with -0.50% considered the most effective lower bound of policy according to the Governor. Negative interest rates means customers are charged interest for their deposits, discouraging savings and encouraging consumption. In case of a further contraction in the economy, fiscal policy stimulus is likely to prove more helpful and effective in fighting a downturn. Nevertheless, Poloz reassured markets that Canada is far off from needing such tremendous procedures as precautionary measures taken earlier are assisting in a return to normalcy.


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