E The Bank Of Canada Takes On A New Approach: Caution Is The Order Of The Day

The Bank of Canada has introduced a new addition to the lexicon used by central bankers.  It will exercise “caution” regarding it rate policy deliberations. While no definition is provided as to what caution actually means in this context, clearly Bank officials have loads of concerns about Canada’s economic performance.

Senior deputy governor at the Bank, Carolyn Wilkins, stated that “we will continue to be cautious in our upcoming policy decisions, guided by incoming data in assessing the economy’s sensitivity to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation”.[1]

If we dissect this statement, we come up with several reasons for the Bank to be very cautious:

• Mortgage rate changes will take effect in January which could have a significant impact on housing and consumer spending; among the changes are the requirement for larger down payments and stress tests on the borrowers’ ability to withstand higher interest rates; the mortgage industry is bracing for a possible slowdown in financing activity;
• Rising household debt has put the brakes on consumer spending after the two recent rate hikes by the Bank; officials will need more time to assess the full impact of the rate increases; Governor Poloz argued that the high levels of debt will make the economy on the whole more sensitive to higher interest rates today than was the case in the past;
• The state of Canada’s housing markets and the associated level of household debt are a major pre-occupation of the Bank[2]. The high cost of housing —in particular, Toronto and Vancouver—posed the most immediate threat to financial stability; today’s consumer has never been more vulnerable to financial shocks;
• Slow wage gains have allowed for very subdued consumer price increases, well-below the Bank’s target of 2%.;
•  Potential level of output, which measures how much an economy can grow before triggering inflation, may well appear to be higher than the Bank’s earlier estimates; this suggests that there is slack in the labor market;