While the Bank of Canada’s decision earlier this month to hold its policy rate steady came as no surprise, the decision did raise the issue of why the Bank dismissed, out of hand, any real prospect of a rate cut. After all, the Federal Reserve has been signaling rate cuts are on their way. Fed speaker after speaker argue the need for an “insurance” rate cut to prevent a recession and to promote continued growth. In Europe, the ECB hints at further monetary stimulation to combat faltering growth and the prospects of disinflation. Further monetary easing by the ECB would take place even though the bank rate is negative and trillions of European bonds (government and corporate) are trading with negative yields. Yet, Governor Poloz of the Bank of Canada did not really entertain any immediate prospects of a shift in policy. Let me offer a few reasons for his resistance.

No headroom to lower rates to fight a recession.  At this point in the long expansionary cycle since the 2008 crisis, nominal interest rates should be much higher. For example, in 2001 the bank rate stood at 5.75%, giving the Bank lots of room to lower the rate to contend with the slump in 2001-2. Again, in the 2007 the bank rate was 4.50% and the Bank drop its rate ultimately to 0.5% as the economy was hit with the worldwide downturn in 2008-9 and the subsequent the collapse of oil prices in 2014.  Simply put, with the bank rate set at 1.75% it would not take much for the bank rate to hit what economists refer to as the “effective lower bound” problem, namely zero interest rates. This is the Bank of Canada’s nightmare scenario. Would moving to zero rates combat a serious recession, especially when the fall in rates is relatively small compared to that experienced in previous recessions? How much can the Bank push on a string?

Concern with the growth in household debt. Bank officials consistently point to the need to be wary of stimulating greater household debt by encouraging more borrowing following rate reductions. The Bank continuously researches the sensitivity of borrowing for consumption and home purchases to rate adjustments. Currently, the bank’s bias appears in the direction of slowing down borrowing, especially in the mortgage market, when it introduced a series of new tighter rules affecting mortgages.

Hoping against hope that the China-US trade disputes will be resolved. This is one of the more confusing aspects of the Bank’s public musings. It knows that Canada is and will continue to be hurt as an innocent bystander in this trade war. As a commodity producer, Canada will suffer as worldwide trade heads south; we are already feeling the effects of the China-US fight. Yet, the Bank continues to build, in its mind, scenarios in which Canada will not be hit hard should that fight worsen. Rightly so, though, the Governor states that rate cuts will not do much to protect Canadians in this case. Many Canadians do not share the view that we will escape unscathed as China and the US square off against each other.

Nonetheless, the Bank of Canada may well face the prospects of dealing with zero short-term interest rates. Evidence is building up daily about the slowdown in Asia, and in particular, in China. US data forecasts now anticipate a significant drop in the growth rate. EU and Japan continue to wallow in stagnation with interest rates at historically low, negative levels. The big question is: how long can the Bank of Canada resist cutting rates?