Bank of Canada’s Stephen Poloz to Bay Street: Can you hear me now?

The central bank governor is trying to find the sweet spot between saying too much and saying too little, and Bank-watchers must adapt

Bank of Canada governor Stephen Poloz

Bank of Canada governor Stephen Poloz. (Chris Young/CP)

Some watchers of the Bank of Canada haven’t been paying attention.

Bloomberg News, Reuters, the Financial Post, and the Globe and Mail’s Report on Business (subscribers only) all wrote about the air pocket the Canadian dollar flew into after Governor Stephen Poloz read his opening statement at the central bank’s quarterly press conference on Oct. 19. Everything was fine after the central bank announced that it had decided to leave its benchmark interest rate at 0.5%, while stating that it had cut its outlook for economic growth and indicating that it would take longer to achieve its inflation target. Those two things should have triggered some repricing, as the Bank of Canada’s outlook had materially changed. But that didn’t happen until Poloz said these words about an hour later: “Given the downgrade to our outlook, Governing Council actively discussed the possibility of adding more monetary stimulus at this time, in order to speed up the return of the economy to full capacity.”

As I wrote earlier this week, it was among the most explicit statements ever made about what went on inside the black box that protects the Bank of Canada’s policy-making process from public view. Poloz and occasionally Carolyn Wilkins, the senior deputy governor, have been using the opening statement at the press conference that follows the release of the Monetary Policy Report as a communications tool for more than two years. Yet some analysts apparently were shocked that the second statement actually contained information. Emanuella Enenajor, an economist at Bank of America Merrill Lynch, described Poloz’s statement for Reuters as “almost like a bombshell.” David Watt of HSBC said there “clearly was a disconnect” between the policy announcement and the statement at the press conference, according to the same Reuters report. “You would like to have more consistency.”

Was the Bank of Canada inconsistent? I don’t think so. It said in the policy statement that U.S. investment, the most important indicator of demand for Canadian exports, “is on a lower track than expected.” Policy makers noted that the recent jump in exports wouldn’t make up for past weakness, forcing them to slash their already meagre forecasts for growth this year and next. The output gap—the difference between current economic output and the estimated level that would stoke inflation—will now close in mid-2018, “materially later” than previously thought, the statement said. So of course the central bank considered further stimulus. To underline the point, the Bank went out of its way to endorse the federal government’s new restrictions on mortgage lending, effectively removing an impediment to lower interest rates.

Unfortunately for the Bank of Canada, market participants have struggled to accept that the paint-by-numbers approach to communication that became the norm during the financial crisis was never meant to last. Central bankers see it as a tool they can use to calibrate their economies, like an interest-rate adjustment or creating money to buy bonds. Most traders “have been taken by the hand for so long that they’ve kind of lost their ability to think for themselves,” Nomura Securities economist Charles St-Arnaud told the Globe. That’s why Bay Street and Wall Street shrugged at the policy statement, and then freaked out when Poloz hit them over the head at the beginning of his press conference.

But just like a teacher works to advance all students to the next grade, a central bank must do what it can to ensure all market participants keep up, even the negligent ones. That means finding a sweet spot between explicit guidance, which breeds complacency, and mystery, which leads to unpleasant surprises. Canada’s economy is weak, yes, but it isn’t a disaster, so Poloz sees no reason to hold the hands of traders. He has said since his debut that if anyone wants to guess where Canadian interest rates are headed, he or she should follow the indicators, just like he does. Indeed, most central banks insist they are “data dependent.” Yet Poloz frames his analysis differently than others, which could be a source of confusion for some.

Unlike some of his peers, Poloz acknowledges that he can’t see the future; therefore, he says the right way to set policy is to balance risks to inflation and financial stability. The Bank of Canada cut interest rates in 2015 because the collapse of oil prices elevated the odds of missing the inflation target to an unacceptable level, trumping whatever concern policy makers had about financial stability. It is an elegant concept, but one that is new, requiring some effort to understand.

And yet one must understand it to recognize the importance of the Bank of Canada’s extended commentary on Finance Minister Bill Morneau’s latest restrictions on mortgage lending. The central bank said the measures, which will make it harder for first-time buyers to obtain loans big enough to buy a decent house at current prices, might hurt the economy in the short term. By limiting the number of riskier borrowers, Morneau has given the Bank of Canada breathing room. With household debt at record levels, the central bank has to think carefully about whether lower interest rates would push the threat of a housing bust outside its comfort zone. That fear has been “mitigated,” Poloz said, giving the central bank greater freedom to cut interest rates, if it feels the need to do so.

Will the Bank of Canada go there? David Parkinson, the Globe and Mail’s lead economics commentator, wrote that the odds of an interest-rate cut by January have surged to “50-50” from essentially zero. CIBC World Markets and Laurentian Bank released commentaries that agreed that lower interests had become a greater possibility. Prices for financial assets tied to the Bank of Canada’s benchmark rate moved, but still suggest most investors think a rate cut is remote. Royal Bank of Canada and National Bank Financial stuck with their calls that the central bank would leave its benchmark rate at 0.5% through 2017 and possibly well into 2018.

It is important to keep in mind that low for longer is stimulative, and that just because Poloz felt the need to signal that lower interest rates are a possibility, doesn’t mean they are an inevitability. Unless conditions get radically worse, there isn’t much monetary policy can do for the economy at this stage. The stimulus from a weaker currency is over; if companies didn’t respond to a 20% drop over two years, they likely aren’t going to respond to a decline of a few more percentage points. The Bank of Canada also noted that there is little else it can do to improve competitiveness: limp productivity, relatively higher electricity prices, and rising protectionism are all beyond the scope of monetary policy.

All the central bank can do currently is ensure buoyancy. Poloz’s message this week was that he is prepared to do what it takes to keep the economy afloat. Faster growth? It is the turn of finance ministers and business leaders to figure that out.