In his final speech of 2018, Governor Stephen S. Poloz discusses the vulnerabilities and risks in Canada’s financial system as well as Canadian and global economic developments. He explains how all this was taken into account in the December interest rate decision.
Interest Rate Decision
Governing Council decided to maintain the interest rate at 1.75 per cent.
Financial Vulnerabilities Matter
After the global financial crisis, Canada needed low interest rates to boost the economy. It took 10 years for the economy to recover—longer than expected.
During that decade, extraordinarily low interest rates encouraged borrowing and spending. The inevitable result has been strong demand for housing, rising house prices and an accumulation of household debt of historic proportions.
The buildup of household debt and imbalances in the housing market has made our financial system more vulnerable to economic shocks.
Positive Signs on Household Debt and House Prices
With the economy healthier, we have raised interest rates five times over the past year and a half.
Governments have also put in place new rules to make borrowing safer. Most new mortgages are tested to ensure borrowers can handle an increase in interest rates.
As a result, borrowing isn’t growing as fast, and the quality of new borrowing is getting better. We know that one way to prevent prices from skyrocketing is to increase the supply of houses and apartments on the market.
We are also making progress in understanding the links between the financial sector and the economy. New data, tools and improved models allow us to capture the rise in financial vulnerabilities and the downside risks to economic growth associated with them.
The overall level of risk to the Canadian financial system remains about the same as it was six months ago, when we published our Financial System Review. New mortgage borrowing is more sound, and house price growth has decelerated. Nevertheless, the stock of household debt will stay high for years, and house prices remain elevated in certain markets.Stephen S. Poloz
Weighing the Risks
In setting the policy interest rate, we need to weigh the risks to growth and inflation from financial vulnerabilities along with the risks from the broader economy.
Since October, concerns of a global economic slowdown have grown. The trade tensions between the United States and China are the main risk. It is a two-sided risk: tensions could get worse and affect Canada, or they could improve, which would be good for global growth and our economy.
Recent data on the Canadian economy have been disappointing. We have seen
- weaker business investment, but we expect it to pick up;
- a slower, but more stable, housing sector; and
- a large drop in the price of oil.
This decline in oil prices is leading to a painful adjustment in Alberta and will have a meaningful impact on the Canadian economy.
- Global oil prices have declined due to lower global demand and higher supply (mostly from the United States).
- Discounts in the price of oil from Western Canada have grown because of transportation bottlenecks, refinery shutdowns and inventory buildups.
- More rail and pipeline capacity and output reductions will help in the long term.
These developments have come at a time when the unemployment rate is at a 40-year low and inflation is close to target, consistent with an economy that has been operating close to its capacity.
Weighing all of these developments, we continue to judge that the policy interest rate will need to rise into a neutral range—somewhere in the neighbourhood of 2.5 to 3.5 per cent—in order to achieve the inflation target. The pace at which this process occurs, of course, will remain decidedly data dependent.Stephen S. Poloz
Updated Forecasts Coming in January
We will update our outlook for the economy and inflation in the Monetary Policy Report on January 9, 2019.