The Bank of Canada took a good look at the Canadian economy, saw it was sinking into the mire, glanced at the collapsed prices of commodities, particularly oil, saw how they were wreaking havoc in Canada, and then looked at the global economy, particularly at China and the US, and it freaked out.
It cut its overnight rate 25 basis points to 0.5%, the second rate cut this year, and attached a gloomy view about the Canadian economy with as it said a “significant downgrade” from its last estimate issued only in April. Things are heading south fast.
In his opening statement, Governor Stephen Poloz blamed oil, China, and dropping exports, particularly to the US which is “still a puzzle that merits further study,” he said, as the swooning Canadian dollar should have pushed up exports. The three culprits:
First, Canadian oil producers have lowered their long-term outlook for global oil prices, and have cut their plans for investment spending significantly more than previously announced.
Second, China’s economy is undergoing a structural transition to slower, domestic-driven growth, which is reducing Canadian exports of a range of other commodities.
Third, Canada’s non-resource exports have also faltered in recent months. While this is partly due to the first-quarter setback in the U.S. economy, it’s still a puzzle that merits further study.
This splits the economy in two, with the “resource economy” falling off a cliff, and with the “non-resource economy” motoring forward. Alas, they’re “not independent – the cancellation of an investment in the oil patch will often lead to a hit in the manufacturing sector, for example.”
Ah yes, and the ballyhooed positive effects of lower oil prices? They “have been slow to emerge.”
The non-resource economy was supposed to pull out the rest, something the BOC expected “to begin in the second quarter. But it did not….” Why not? Poloz blamed the three culprits above. And that propitious moment is now rescheduled for the third quarter. Or maybe later.
But the rate cut comes at the price of “financial stability risks” which “remain elevated,” Poloz said. “Of particular note are the vulnerabilities associated with household debt and rising housing prices.”
Household indebtedness, driven by ballooning mortgages, has soared over the years. The household-debt-to-disposable-income ratio now hovers at 163.3%. And home prices, funded by this boom in debt, have also soared. They now exceed the peak of the prior housing bubble by 27% on average across major metro areas, and in Toronto by 45%.
It’s a majestic housing bubble. Even the IMF is fretting about it. When housing bubbles implode they do enormous damage to the real economy and to the financial system.
But rather than trying to tamp down on it, the Bank of Canada is going to feed it with even cheaper money, while openly fretting about it… Governor Poloz warned that the rate cut “could exacerbate these vulnerabilities.”
However, these “financial vulnerabilities would usually translate into full-blown risks – with attendant consequences for the economy – only if there was a trigger,” he said. But these triggers are already visible, such as:
A widespread and sharp decline in economic activity and employment.
The terms-of-trade shock we are experiencing, which has already translated into an increase in excess capacity and downward pressure on inflation…, if left unaddressed.
So “the Canadian economy is undergoing a significant and complex adjustment, even while it is still trying to overcome persistent global headwinds.”
While it was at it, the BOC slashed its Q2 “growth” estimate from a positive +1.8% in April to a negative -0.5%. That’s a huge cut from just three months ago! And it comes on top of the contraction (-0.6%) in the first quarter. Even the BOC is now admitting that Canada is in a technical recession – two quarters in a row of contraction.
It also slashed Q3 growth from 2.8% in April to 1.5%, still a positive number that, given the “global headwinds,” may be tough to achieve. But it left Q4 unchanged at 2.5% because “solid household spending” would by then “be supplemented by a continued recovery in non-energy exports and investment.”
That’s the hope. It brings the growth forecast for 2015 to a measly but still optimistic 1.1%. Three months from now, the BOC will slash it further.
It also cut its growth forecast for 2016 to 2.3%. A lot of good things would have to happen around the globe, including surging oil prices, for this to happen. And the housing bubble would have to continue to bloom, or else, it would turn into one of the “triggers” for financial instability that Poloz is worrying about.
This was a big dose of gloom for just one statement. In sympathy, the already beaten-down Canadian dollar plunged 1.5% against the US dollar, hitting the lowest level since February 2009.
Written between every line of the statement was the housing bubble, the risk it posed to the economy and to financial stability, and the tradeoffs the BOC had to consider.
A collapse of the housing bubble would be one of the “triggers” to financial stability risks. Hence the need to keep it inflated. Hence the rate cut. But the cut will in turn “exacerbate these vulnerabilities,” as Poloz admitted. That’s the Catch-22 a loosey-goosey monetary policy finds itself in sooner or later: no matter which direction policy goes – rate cuts, no change, or rate hikes – it simply exacerbates one or the other of a slew of already enormous risks, each of which could trigger a major debacle.
But something happened in the housing market that shocked analysts, though they immediately said that it was not “an early signal of rising losses or broader housing stress.” Read… Largest “Alternative” Mortgage Lender in Canada Plunges, Denies “Systemic Problem” in Housing Market