bank-of-canada Photo: Mikey G Ottawa/Flickr

In recent years, a number of central banks have set interest rates to below zero, and in late January, the Bank of Japan became the latest to do so, sparking commentary from observers about what it would mean if Canadian policymakers tried this out.

However, the Bank of Canada isn’t likely to attempt a similar gambit with its own key interest rate, which influences mortgage rates, at least for the time being, says a leading economic research firm.

“Economic growth and inflation in Canada will be buffered by fiscal policy stimulus and the past depreciation of the Canadian dollar,” writes David Madani, Capital Economics’ senior Canada economist, in a report.

“Accordingly, we don’t foresee the Bank of Canada introducing negative interest rates anytime soon,” he continues, noting the central bank’s current key interest rate of 0.50 per cent is already “very low.”

A plan to fund infrastructure projects in the hopes of giving a shot in the arm to the economy was part of the Liberals’ campaign ahead of the party’s election in October.

“We will run modest short-term deficits of less than $10 billion in each of the next two fiscal years to fund historic investments in infrastructure and our middle class,” the Grits’ official platform states.

Capital Economics expects the actual plan, which the Liberal party has yet to roll out, will be more robust than what was outlined during the election.

Because the Canadian government isn’t burdened with high levels of debt, it has wiggle room to channel more funding into these projects, Capital Economics’ report suggests.

“We expect fiscal policy to play the leading role over the next few years, with monetary policy taking on a supporting role,” says Madani.

Government spending falls under the umbrella of fiscal policy while monetary policy includes the Bank of Canada’s actions.

The key interest rate of 0.5 per cent is currently 25 basis points above the interest rate the bank pays to financial institutions depositing money with it overnight and 25 basis points below the interest it charges to those borrowing from it.

A key interest rate below zero, which is a negative rate, requires financial institutions to pay the Bank of Canada to deposit money with it, rather than allowing them to accrue interest as they do now.

Madani says there are reasons other than fiscal stimulus to doubt the Bank of Canada cutting the key interest rate to below zero.

“To begin with, borrowers in Canada are already enjoying some of the lowest borrowing costs in the developed world, especially mortgage rates,” says Madani.

He points out that household debt has soared to never-before-seen heights and home prices across a number of major Canadian cities “are completely detached from household income fundamentals.”

Madani also takes the Bank of Canada’s decision to stand pat on the key interest rate last month as a sign that it isn’t likely to cut rates in the near-term.

The central bank opted not to further reduce the overnight lending rate in January based on the idea that the lower Canadian dollar would encourage an uptick in exports to compensate for the oil-price shock walloping the energy industry, one of the largest segments of the nation’s economy.

A month earlier, Stephen Poloz, the Bank of Canada’s Governor, stated the bank isn’t ruling out the possibility of negative interest rates in the future. This marked a departure from a policy statement in 2009.

However, Madani says the risk of over-leveraged consumers in a struggling economy has Canadian banks concerned, a sentiment reflected in borrowing rates that are inching higher, the Bank of Canada’s overnight lending rate cuts last year notwithstanding.

If the central bank did choose to cut the key interest rate again, it is not clear savings would be passed on to consumers.

“All things considered, with household and business borrowing rates as low as they are likely to go and household debt at record highs, the effectiveness of monetary policy at stimulating domestic demand is now more limited than ever before,” Madani says.

Developments featured in this article

More Like This

Facebook Chatter