For a moment this week, Stephen Poloz, Bank of Canada Governor, sounded like he was ready to take a pause from his frenetic efforts to prevent a recession. Nope. “I was being very careful not to rule out actions at any time,” Poloz said on March 18. “There is nothing scripted about the bank’s posture.”
If Poloz’s peers are any guide, Canadian borrowers should expect more stimulus.
The Reserve Bank of Australia, European Central Bank and Bank of England all said this week that they would create hundreds of billions of dollars, euros and pounds to buy bonds. In the United States, the Federal Reserve said it would back money-markets funds, promised more central banks that they would have access to U.S. dollars if their banks run short, and continued to push tens of billions of dollars into the financial system.
Global markets on Friday morning were buoyant for a second consecutive day, suggesting that all the extraordinary rate cutting and bond buying was making a difference, though the good mood didn’t last long. That’s probably a reason for central banks to keep pushing rather than take a break. “The world is going through an atypical economic downturn,” Sébastien Lavoie, chief economist at Laurentian Bank, said. “It is going to be sharp in March and April.”
You need to go back six years to understand how the Bank of Canada will approach the weeks ahead.
Poloz in 2014 published a paper called Integrating Uncertainty and Monetary Policy-Making: A Practitioner’s Perspective. He described central banking as an executive might talk about deal-making: rather than be mechanical, a responsible central banker adjusts the present value of an idea to reflect future conditions.
This “risk-management” strategy crystallized over the past nine months, as Poloz and his deputies held firm while other central banks cut interest rates last year to offset the trade wars. They decided that whatever gains might come from lower borrowing costs in the short term paled against what might happen if Canadian households resumed adding to their scary piles of debt. The balance of risks changed in February, when it became clear that the COVID-19 outbreak could cause a global recession, and commodity prices collapsed in the span of a few weeks.
How might the Bank of Canada balance risks from here?
In some ways, the decision is easier than last year because the threat is clear and present. Poloz and his deputies dropped the benchmark rate a full percentage point in less than two weeks, a faster pivot than the central bank made at the onset of the financial crisis in 2008, when it dropped the overnight target by three-quarters of a point between Oct. 8 and Oct. 21.
The Bank of Canada’s next move back then was an aggressive three-quarter point cut at the end of its December policy meeting, lowering the benchmark rate to 1.5 per cent. Poloz’s central bank entered the coronavirus crisis much closer to zero. Mark Carney, the previous governor, would over the following four months cut the target rate to 0.25 per cent, the lowest setting ever, appropriate at a moment when serious people thought a global depression was possible.
Today, prices of financial assets tied to short-term interest rates imply that investors think Poloz will return the overnight target to that level by April, if not before.
That seems a safe bet. A decade ago, the Bank of Canada thought 0.25 per cent was as low as it could go without wrecking the banking system. That’s no longer the case. The Bank of Japan and various European central banks have been running negative rates for years, and there is general agreement that the strategy can help, if only a little. The Bank of Canada now thinks that its “effective lower bound” is probably around -0.5 per cent.
With the Fed already at zero and the Bank of England at 0.1 per cent, Bay Street and Wall Street speculation is that the central banks that avoided negative rates during the financial crisis will be forced to go there by COVID-19.
Things would have to go terribly wrong for Canada to try it, at least as long as Poloz is governor.
In 2015, the central bank updated its playbook for what it would do if the benchmark rate ever got to zero. Negative rates are in the toolkit, but Poloz has been clear that he sees the gambit as a desperation move. “It’s not a happy place for the banking system,” he said on March 13.
The pace of interest-rate cuts could be influenced by the exchange rate. The Bank of Canada indicated discomfort when the dollar approached 75 U.S. cents last year. The currency was trading at around 70 cents at the end of this week, reflecting the collapse in oil prices. That means two things. One, traders are doing some of the Bank of Canada’s work for it, buying policy-makers some time. The central bank also seeks to avoid volatility, which is another reason to slow down, as more cuts would put downward pressure on the currency.
In 2009, Carney sought to instil confidence by promising to leave the benchmark rate at 0.25 per cent for a year. That tool would come into play before negative rates.
But Poloz seems keenest about the various schemes he’s deployed over the past couple of weeks to backstop specific credit markets. For example, the Bank of Canada purchased $305-million worth of mortgage-backed securities on March 19, and plans to buy $15-billion worth of bankers’ acceptances on March 23 to support small-business lending. These are twists on old techniques, and the central bank is probably only getting started.
“The main thing is that most of these things are scalable,” Poloz said. “We will scale that as needed. Whatever the system needs, that’s what we will provide.”