David Parkinson - ECONOMICS REPORTER
The Globe and Mail
Published Monday, Sep. 22 2014, 1:32 PM EDT
Canadian interest rates will likely peak at lower levels than they have in the past, the Bank of Canada’s second in command says – and the central bank might keep rates low even once the economy has returned to full throttle.
Senior Deputy Governor Carolyn Wilkins told a luncheon audience in Toronto’s financial district that the country’s “neutral” interest rate – the level that would sustain the economy at full capacity and keep inflation in line with the central bank’s 2-per-cent target, which functionally implies an upper range for the bank’s key policy rate – is now likely “3 to 4 per cent,” roughly 1.5 percentage points below its historical norm.
She said “structural developments” in the aftermath of the financial crisis and Great Recession – including a shrinking work force, a higher level of global savings and tougher capital requirements for the financial sector – will limit economic growth potential, keeping a lid on interest rates.
Ms. Wilkins said the central bank now believes the Canadian economy’s potential output growth will average “just below 2 per cent” over the next two years – a full percentage point lower than in the decade prior to the recession.
She cautioned that even when the Canadian economy moves up to full capacity and inflation stabilizes around the bank’s 2-per-cent target, the bank may see fit to maintain a policy rate below the new neutral range. “As long as the factors leaning on growth persist, a policy rate below neutral would be required to maintain inflation sustainably at target,” she said.
The speech, Ms. Wilkins’s first public address since becoming senior deputy governor last May, marks the beginning of the central bank’s public discussion around what is fast becoming a key question for the world’s central bankers: Whether economic potential and, by extension, interest rates have shifted permanently lower in the wake of the crisis and recession. Central bankers in the United States and Britain have been addressing their neutral-rate expectations in increasing detail recently, but this is the first significant public airing of the thinking at the Bank of Canada, which isn’t expected to begin raising rates until well after its U.S. and British counterparts.
“In our view, this is a very important speech because it set guidelines about the expected evolution of monetary policy over the coming years,” National Bank Financial economists Paul-André Pinsonnault and Krishen Rangasamy said in a research note. “The speech … should fuel speculation that the Bank of Canada [will] delay rate hikes for as long as possible.”
For central bankers, the neutral interest rate is an important concept for setting an appropriate course for interest rates, and for understanding the potential economic impact of rate changes. For investors, it’s a key indicator of long-term expectations for investment returns, and affects investment decisions. And for consumers, the likely path of interest rates will be a key factor in how well they will be able to manage debts and afford loans, including mortgages, over the next several years.
The question of where neutral rates now stand has gained prominence as key central banks such as the U.S. Federal Reserve and the Bank of England inch closer to raising rates, ending a stretch of more than five years of holding their official policy rates at near-zero levels. The Bank of Canada has kept its policy rate at 1 per cent since September, 2010.
Economists agree that neutral rates, particularly in the world’s developed economies, are lower now than they were before the crisis and recession. But there’s a wide range of opinion among experts, including those at central banks, about just how low the “new normal” for neutral rates will be. Bank of England Governor Mark Carney recently suggested the British central bank’s neutral policy rate could be about 2.5 per cent, roughly half of its prerecession level. But last week’s update of the Fed’s outlook indicated that its policy makers expect a long-run neutral rate of about 3.75 per cent, compared with a prerecession norm of about 4.25 per cent.
Bank of Canada Governor Stephen Poloz said in a CBC radio interview in July that the bank would address the neutral-rate issue in its next monetary policy report, which comes out on Oct. 22. Ms. Wilkins said the report would also update the bank’s outlook on the economy’s output growth potential.