No Bank of Canada interest rate hike expected Wednesday

The Bank of Canada isn't expected to change its benchmark interest rate on Wednesday. But that doesn't mean it thinks the Canadian economy is chugging along normally.

Governor Stephen Poloz and deputy governor Carolyn Wilkins are set to reveal the bank's latest interest rate policy on Wednesday at 10 a.m. ET. Judging by trading in financial instruments known as interest rate swaps, investors think there's less than a one in five chance of the bank raising its target for the overnight rate above where it is now — 1.25 per cent.

The bank has ratcheted its rate up three times since last summer, bringing an end to the era of record low interest rates.

Watchers expect the bank to nudge its rate up another quarter of a percentage point in May, or no later than July. But if it does what's expected on Wednesday and sits this one out, it won't be because the bank thinks things are going swimmingly.

Growing debt loads

Debt loads, for one, are a concern. After setting record high after record high for years, a closely watched debt metric reached something of a tipping point since the last time the bank hiked its rate. In March, Statistics Canada reported that the debt to income ratio — the amount that Canadians owe compared to what they have to spend — inched down in the first part of 2018, to just over 170 per cent.

Technically, debt loads aren't the central banks problem. They only worry about them inasmuch as they have the potential to impact other parts of the economy. But economist Royce Mendes with CIBC said ignoring debt loads is easier said than done for the central bank.

"It is a very uncertain environment for the Bank of Canada to be hiking into," he said in an interview. "We've never seen that much leverage in the system."

Twenty years ago, inching lending rates from, say, eight per cent to 8.25 per cent would likely not have spelled the end for most borrowers. But with the overall debt load being so much larger now, every jostle is felt that much harder.

"Every rate hike is that much more powerful than it was before," Mendes said. "And there's no clear historical example to go off of."

Shifting economic winds

There's ample evidence outside debt that suggests the economy may have taken a turn for the worse. Monthly job figures are notoriously volatile, but even by their standards, the figures for January landed with a thud.

According to Statistics Canada, the economy lost 88,000 jobs that month, its worst showing in nine years. While in all likelihood that loss was a blip, the hue and cry over minimum wage hikes, and a slowdown in real estate that was big enough to take a bite out of GDP could be reason enough for caution moving forward.

While the jobless rate remains low and output continues to expand, Toronto-Dominion Bank economist Dina Ignjatovic says it's undeniable that the outlook has changed, and not necessarily for the better.

"Economic growth seems to have gotten off to a slow start this year," she said. While she's not expecting anything as dramatic as a rate cut, "The bank's outlook is likely to be downgraded."

NAFTA uncertainty

And then there's NAFTA. Negotiations for a new trade deal have dragged on for months, and while they seem to have taken a step in the right direction of late, there's little certainty that anything concrete will get done anytime soon.

The U.S. is the destination for three-quarters of Canadian exports and more than half of its imports, so any level of uncertainty there is a huge dark cloud on the horizon for the Bank of Canada to forecast around. Faced with uncertainty like that, there little it can do besides wait and see.

As economist Derek Holt put it in a note to clients on Tuesday, "The Bank of Canada faces a conundrum of sorts. Growth has been somewhat disappointing for some time now while NAFTA and broader trade policy risks remain significant," he said. "Yet ... price pressures are building."

Inflation heating up

"Price pressures are building" is economist-speak for inflation, which, strictly speaking, is the central bank's only actual job.

The bank's mandate is to target inflation to keep it in a range of between one and three per cent. All things being equal, the bank hikes rates when inflation is too high, and cuts them when it is too low.

It's right in that range at the moment at 2.2 per cent, and while economists expect that number to have warmed up a little in March, it's also no reason to panic one way or the other.

That being the case, Mendes argues that staying the course now would be a sign that previous policies are working just fine.

"We're not suggesting the Bank of Canada hikes interest rates into this," Mendes says. "We would suggest that they leave some stimulus in the system to hopefully continue that momentum moving forward."

Some have suggested that the bank needs to hike its benchmark rate now just to give itself some wiggle room to cut again later, should the need arise. But Mendes rejects that notion, too.

Raising rates now just so you can cut them later if you have to, Mendes says, would be like "slamming on the brakes, so that you can speed up ahead to get to the hospital as fast as possible."