3Q CENTRAL BANKING: Canada's Path to a Rate Cut Has Possible Pitfalls

 
   By Don Curren 
 

        The next three months could be a "make-or-break" period for the Bank of Canada's neutral policy stance.
        Canada's central bank has been neutral on monetary policy since it cut its policy rate by a quarter of a percentage point to 0.75% in January. It described the cut--which surprised markets--as a form of "insurance" against the potential damage to Canada's economy from the drop in prices for crude oil, the country's biggest export.
        The Bank of Canada has kept interest rates steady since then, based in large part on the expectation that Canada's economy will bounce back strongly in the second half of the year after its 0.6% contraction in the first quarter.
        Economists who accept that optimistic view--and there are many outside the central bank--believe increased demand from the accelerating U.S. economy and low Canadian dollar still stimulate Canada's export sector.
        That, in turn, is expected to foster an increase in business investment. Increases in both Canadian exports and investment are crucial, since the BOC is hoping those sectors will become growth leaders, taking the burden of driving growth off the shoulders of heavily indebted consumers.
        But so far there's no compelling evidence that shift is under way, according to some economists.
        The high debt carried by Canadian households is the other thorny problem faced by the central bank. Years of ultra-low interest rates have fueled a relentless rise in housing prices, and with it a sustained climb in household debt, the bulk of which is mortgages and credit based on homeowners' equity.
        Some economists believe Canada's housing market is at risk of a sharp, destabilizing correction. That's not what the BOC anticipates, but it recognizes that high household debt does pose a risk to the country's financial stability.
        So even if growth remains feeble in the second half, the BOC might be reluctant to cut rates out of fear that would foster more consumer borrowing and raise the risks to financial stability.
        Write to Don Curren at don.curren@wsj.com
        (END) Dow Jones Newswires

        July 08, 2015 05:59 ET (09:59 GMT)

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