Central Banks Take Center Stage (Again!)

The European Central Bank (ECB) surprised financial markets this morning with an easing of monetary policy: stating that interest rates would stay at 0% at least until the end of the year (longer than the original plan) and would initiate a new series of long-term business loans (TLTRO) that would add liquidity to the European financial system.

Yesterday the Bank of Canada left it's monetary policy unchanged (the overnight rate at 1.75%), despite admitting that: "Recent data suggest that the global economy has been more pronounced and widespread than the Bank had forecast in its January Monetary Policy Report (MPR)". About the Canadian economy: "After growing at a pace of 1.8% in 2018, it now appears that the economy will be weaker in the first half of 2019 than the bank projected in January."

Interestingly, yesterday as well, the Organization for Economic Co-operation and Development (OECD), lowered its global forecast and dropped Canada's 2019 GDP expectations from 1.8% annual growth to 1.5%. They lowered the Eurozone economy from 1.8% to 1.0%.

Compare this picture:

With the Canadian situation (at the top).

Interest rates in the Eurozone are already at zero. Inflation in the Eurozone (February data) is at 1.5%. Inflation in Canada is running at 1.4% (January data), but the BOC measures of core inflation are running near 1.8-1.9%.

The BOC also stated yesterday that: "Governing Council judges that the outlook continues to warrant a policy interest rate that is below its neutral range."

I did message the BOC Twitter feed (@bankofcanada) asking for a broader explanation of what actually was "neutral". My @JSTomenson feed received no reply. However, in their fairly recent efforts to reach the average Canadian household on their level, they did release this (via their Twitter feed): "Price Check: Inflation In Canada".

"Of course, the Bank doesn't respond to every movement in inflation or focus on prices that move around a lot", perhaps a reference to the drop to a total CPI report of a 1.4% annual increase in January from the 2.0% December number. 

"The Bank focuses on changes that are more widespread and persistent".

When they started raising rates back in the summer of 2017, the BOC used the analogy of "putting their foot on the brakes before the light changed to red" or something of that nature (see my blog: Higher Borrowing Costs = Big Risk For Bank of Canada)

Clearly, the Canadian economy has been slowing since then and the expectations of higher inflation have not taken us much above the 2% level of the BOC's core inflation data.

So what, exactly is the BOC's "neutral" rate of interest that should be indicative of an economy with "neutral" growth and "neutral" inflation?

I might be so bold as to suggest that they are somewhat high on their estimate of "neutral" interest rates and without some action more than an acknowledgement that their economic growth estimates were too strong (as in some more aggressive monetary easing like the ECB just announced, i.e. an interest rate cut), the downside risk to the Canadian economy will likely be elevated.

Interesting that the BOC was quick to change to an aggressive tightening of policy back in 2017, but remains less aggressive to go the other way, when it is clear that the Canadian economy is in some trouble, loan delinquency is rising (higher debt servicing costs for Canadians) and the global economy is not helping.