Bank of Canada seen setting own course

As the buzz of possible interest-rate cuts from the U.S. Federal Reserve Board sweeps through global financial markets, some of Canada's top economists have a message for Canadian rate watchers: Don't expect the Bank of Canada to follow the Fed, and don't expect its officials to talk much about it.

While the Fed has become increasingly talkative in an attempt to more clearly signal its distaste for an immediate cut to its benchmark federal funds rate, the Bank of Canada has restricted its comments to its efforts to provide liquidity and its support for moves by financial institutions to shore up the wobbling asset-backed commercial paper market. In fact, no senior Bank of Canada official has made a public address since mid-July.

In the absence of fresh guidance from the central bank, the markets priced out the possibility of a 25-basis-point rate increase at the bank's next rate-setting meeting on Sept. 5 - an increase that had been considered all but a done deal following the bank's rate hike in July, when it signalled more to come. (A basis point is 1/100th of a percentage point.) In a new poll conducted by Reuters, all 11 economists surveyed expect the bank to hold rates steady on Sept. 5.

Yesterday's Canadian inflation report also eased pressure on the Bank of Canada to raise rates. Consumer price index inflation came in at an annualized rate of 2.2 per cent in July, a shade above the 2-per-cent midpoint of the Bank of Canada's target range, while the more closely watched core inflation rate slipped to 2.3 per cent from June's 2.5 per cent.


Canadian observers are not only unfazed by the central bank's silence on the economic and monetary front, they believe it's wholly appropriate and sends the right signal.

"I think the Bank of Canada is playing this right," said Don Drummond, chief economist at Toronto-Dominion Bank. "This is a liquidity problem, not an economic problem. If you have a liquidity problem, you need to do things that directly deal with liquidity. They've done that."

BMO Nesbitt Burns chief economist Sherry Cooper, who once worked at the Fed in Washington, said Bank of Canada officials are typically more reticent than their counterparts at the Fed, which under former chairman Alan Greenspan gave license to its numerous regional presidents to speak their own minds - a policy that some cynical Fed watchers have dubbed the "open mouth policy."

She said that while she "wouldn't be surprised" if Bank of Canada Governor David Dodge or one of his senior deputies were to comment on the market and economic conditions in the coming days, it's increasingly unlikely with the bank now just two weeks away from its Sept. 5 rate announcement - and just one week away from the preannouncement "blackout" period during which all officials are banned from talking publicly.

Still, she believes the prevailing market conditions have all but demanded that the Bank of Canada hold rates steady - even if Canada's economic conditions have been pointing to the need for further rate hikes to keep the economy and inflation in check.

"When there are just your typical market gyrations, the bank can look through that. But these aren't your typical gyrations," she said.

On the other hand, the bank would have to see some spillover of the credit-market turmoil into the broader economy before it considers rate cuts. And while there is growing risk of just that happening in the United States, the Canadian economy is in a stronger position, experts say.

"There is a greater event risk to the U.S. economy," said Stewart Hall, foreign-exchange and bond market strategist at HSBC Securities Canada Inc. "The approach [by central banks] has to be tailor-made."

He said that most central banks around the developed world continue to treat the credit crunch as "a market-specific problem," and thus have been reluctant to alter the direction of monetary policy, something the Fed is also trying to do. (Central banks in Norway, Australia and China have all raised rates this month.) He suggested that as long as the Fed doesn't hit the panic button, other major central banks will stay the course.

The key to whether the Bank of Canada looks to resume rate hikes at the following rate-setting date in October, holds steady or even considers cuts, is whether the market turmoil shows evidence of leaking into the economy.

The Reuters poll showed five economists expecting an October rate hike, five expecting the central bank to stay on hold, and one anticipating a rate cut.

"For the bank to even hint of getting in there [with a rate cut], they'd have to see some sign of economic damage," Mr. Drummond said.

(prepared by David Parkinson/Globe and Mail)