At a Bank of Canada interest-rate statement that conducts 385 words, that word — in the last sentence of this statement — was the only one that really mattered to financial markets. To dealers parsing the central bank’s most current communication, it not only justified the bank’s decision to maintain its key rate steady at 1 percent (which was expected), but signalled that the lender is also not likely to increase rates at the next decision date, in mid-January.
It was the second time that the Bank of Canada used “careful” to describe its approach to future rate rises, after having raised rates twice in the summer. But it looks like the term is already considered, by dealers, at least, to be the bank’s shorthand for “no prices ahead until we cease saying this term.”
The evidence of this conviction was over the markets on Wednesday. The bond market instantly reduced its pricing of the likelihood of a January increase to 25 percent, from about 40 percent the day prior to the announcement. The Canadian dollar tanked on the diminished interest-rate expectations; by late afternoon, it had dropped eight-tenths of a cent against its U.S. counterpart.
Thing is, if you’d read everything in the speed statement up to the look of “careful,” you may have thought the Bank of Canada was prepared to take a step toward another rate increase, not a step back. On most fronts, the central bank seemed more encouraged by economic developments. Global expansion continues apace and the U.S. market has been stronger than anticipated. Business investment and government infrastructure spending are both giving the Canadian market a lift. Slack in the labor market is “diminishing.” Inflation has been rising — indeed, faster than previously expected, although temporary variables are contributing. (When do they not?) The lender even squeezed in a sentence about the most recent monthly trade data — published just the day before, pretty much in the cable for inclusion in the rate statement — to state the numbers support expectations that export growth could bounce back from a tepid third quarter.
Yet “careful” trumped all that.
Typically, that’s the type of thing that would annoy the Bank of Canada. Its communications team have been frustrated before by economies latching onto one word or phrase, as opposed to reading the entirety of its message and therefore misreading the lender’s intent.
But in this instance, the lender has made it fairly clear that warning is quite central to the present thinking. If anyone had not grasped the importance of the word once the bank introduced it to its speed announcement in October, the bank’s second-in-command, Senior Deputy Governor Carolyn Wilkins, dedicated a significant chunk of into the need for a careful approach to setting monetary policy amid doubt. As soon as you give a speech like that, you need to anticipate that observers will be seeing that specific part of your communications especially carefully — that, you have to complete, was the bank’s intent.
And there are a couple of uncertainties which are coming crunch time for Canada’s central bankers. They’re not entirely certain how the two rate hikes of earlier this year will impact economic growth, as the elevated levels of Canadian household debt may indicate that higher prices will deliver a bigger-than-usual blow to consumer spending. They are not sure how much slack remains in the labor market and to what level it will activate wage inflation, which has been very slow to take hold in this economic recovery. They are not entirely sure how close the economy is to complete capacity — the crucial gauge for assessing how desperately rate increases are required to keep the economy from overheating.
The granddaddy of doubts is that the danger of a NAFTA collapse. The Bank of Canada did not mention NAFTA by title in its speed statement, but there is no doubt that it casts a shadow over its outlook for rate policy. If the central bank were to get more aggressive in raising rates in the upcoming few months and then the NAFTA talks were to fall apart, it would most likely constitute an economic jolt warranting a reversal of these hikes — the way the Bank of England cut rates in a quick response to the Brexit vote. However, Ms. Wilkins made clear in her speech that the lender has a distaste for reversing a rate-hiking cycle after one has begun.
Still, the markets will need to use some caution in placing too much weight to what they think the Bank of Canada is signalling. This is a central bank which, in the previous three decades, has amazed markets not once but twice with speed moves which weren’t foreshadowed in the bank’s communications. Governor Stephen Poloz has demonstrated a willingness to act without sending progress signs, and has seldom allowed his policy to be defined narrowly with a particular term or phrase, or the lack thereof.
Mr. Poloz has spent much of his tenure in the governor’s office advising the markets to see the financial data and think for themselves. The next rate increase will come when the economic indicators have persuaded the Bank of Canada that it is time — no matter which term it uses to explain how it approached that choice.