Worldwide central banks are taking a more open-minded approach towards interest rate cuts. The Federal Reserve dropped its benchmark rate by 25 bps in late July;  the ECB is strongly hinting that it will cut its policy rate further into negative territory; the Bank of England remains poised to slash its rate in response to the fallout from Brexit; and a host of emerging market economies have moved to cut rates in the wake of turmoil hitting the international trading community. The lone holdout, so far, is the Bank of Canada (BoC) which just announced that it will maintain its policy rate at 1.75% for the seventh consequent month. While this decision did not come as any surprise, many analysts expected that the BoC would signal that it, too, will likely be, adjusting rates downward. The BoC statement provided no hint that rate cuts would be forthcoming. Instead, it adopted, at best, a wait and see attitude.

What are some of the risks the BoC is taking in holding the line against future rate cuts?

Above all else, the deterioration in the China-US trade war weighs heavily upon all central bankers. Recent statements by the St. Louis Federal Reserve President James Bullard call for a 50bps rate cut now to counteract the effects of a global trade war. Evidence of a slowdown in the US is mounting, most recently as the  U.S manufacturing contracts, largely in response to the ratcheting effect of tariffs by China and the US. Fed Chairman Powell has let it be known that he is receptive to further rate cuts, giving rise to a widespread expectation that the Fed will cut another quarter-point at its next meeting in two weeks.

The BoC recognizes that the “escalating trade conflicts and related uncertainty are taking a toll on the global and Canadian economies”.However, it sees no reason to act now to cushion the impact of these conflicts on the Canadian economy. Given that rate cuts take from 6 to 9 months to have their full impact, events may well overtake the BoC. International trade conflicts are accelerating, leaving the BoC with little time to respond effectively, should conditions sour further.

In a similar vein, the lags in monetary policy imply that we cannot expect any significant upswing in business investment over the next twelve months. Business expenditures on plant and equipment have already declined by 1.6% in the second quarter, according to the Bank because of “heighten trade uncertainty”.Perhaps the strangest aspect of the Bank’s statement is the acknowledgment that it expects “economic activity to slow in the second half of the year”, yet sees no reason to counter this development by lowering borrowing costs.

The Canadian bond market does not support the BoC’s approach. Not only has the yield curve fully inverted, but also the key area, the 3-5-year yields, have already brought borrowing costs down substantially, especially for mortgages and corporate bonds. In this respect, the bond market has essentially circumvented the BoC rate policy when it comes to the question of providing economic stimulus.