The BoC, Kohly explained, differentiated between cyclical and structural weakness in its monetary policy report. Cyclical weakness is the kind of issue that rate cuts and monetary policy can help deal with. Structural weakness, however, is more exposed to trade policy overhangs and the BoC’s own monetary policy report published Wednesday explained how little a central bank can do to actually address that issue. Kohly’s view, therefore, is that the BoC won’t cut interest rates again unless Canada falls into a recession.
Kohly describes the BoC’s position as challenging, noting that despite some growth overhangs, the bank has a single mandate of controlling inflation. Even if structural weakness is now a factor in the economy, the BoC has to stay focused on CPI, which does appear to stay somewhat higher.
“The most recent Canadian Survey of Consumer Expectations suggests a negative impact on consumer spending from high prices of goods and services and economic uncertainty, while firms’ investment expectations remain subdued amid a soft sales outlook, excess capacity, and limited ability to pass on higher costs,” said Kathrin Forrest, Equity Investment Director at Capital Group.
While Kohly sees challenges to any future BoC cuts, he thinks the Fed has plenty of room to cut. In part because they’re operating from a higher benchmark rate, but also because of the political pressure from the Trump administration to cut rates further. Moreover, Kohly sees the disconnect between the BoC and Fed benchmark rates as likely unsustainable in the long-term, agreeing that the likely reason the wide delta has not yet wreaked havoc on the Canadian dollar is largely a result of the secular decline in the USD that emerged from the onset of US global tariffs. He believes the economies remain highly correlated despite trade tensions and that US fed policy will gradually work its way down to a point within one per cent of BoC rates.
If Kohly’s prediction holds and the BoC can’t cut to undo structural weaknesses in the economy, then fiscal policy must play a role. Next week the Carney government will release its first budget since the election and Kohly expects a large deficit. He says, though, that not all spending will be unwelcome. Signs of productivity investment and capital expenditure may be greeted warmly, as would cuts or efficiencies on the operations side of government. He notes, too, that Canada has fiscal room to spend compared to our OECD peers, though he caveats that by saying it’s something of a ‘race to the bottom.’
