Economic slowdown puts interest rate hikes on hold

Was it only last fall when the central banks of the United States and Canada were talking about several interest rate hikes in 2019?

With the economies apparently booming, it was time to tap the brakes to prevent the growth of inflation and to get interest rates up to a more normal level, after a decade of very low, stimulative levels.

The U.S. Federal Reserve raised rates four times last year and as recently as December said it might raise them again two more times in 2019. The Bank of Canada from the summer of 2017 to October 2018 raised rates five times.

That policy is now reversed as several measures show economic growth rapidly slowing. On March 20, the U.S. Fed said it expected no rate hikes this year.

The Bank of Canada has not increased its rate since October and says there is “increased uncertainty” about the timing of the next rise. Indeed some private analysts now say interest rate cuts might be in the cards.

That might be good news for those carrying heavy debt but the overall deteriorating economic outlook has implications for the Canadian dollar. And the path of the currency affects the price of Canadian crops and livestock.

TD Securities raised eyebrows recently when it predicted the Canadian dollar could fall as low as US71 cents by the end of the year. But that view is more pessimistic than most. Indeed, currency forecasts by the Royal Bank, CIBC and National Bank all see the loonie staying in the mid-70-cent range through the year.

The Canadian economy by some measures is doing well.

The Toronto Stock Exchange composite index had a super first quarter, regaining all the ground it lost in the second half of last year.

Canadian employment gains have been substantial. With a strong February jobs report, employment over the past 12 months increased by almost 370,000 jobs and the unemployment rate has fallen to 5.8 percent.

Canada’s gross domestic product grew at a faster-than-expected 0.3 percent in January, raising hopes that the near-zero growth in the fourth quarter of 2018 was just a temporary stumble.

However, Canadian consumers, particularly those in big cities with high housing prices, carry heavy debt and are having trouble shouldering the weight of last year’s interest-rate increases, meaning that consumer spending will likely be tight. The stricter mortgage guidelines brought in to cool overheated housing markets are having their intended effect.

International oil prices are weakened by a capacity to produce more than demand and are held up only by agreements by the Organization of Petroleum Exporting Countries and Russia to limit production. In Canada, the pipeline capacity constraints further depress oil prices and weakens capital investment in the oil patch.

Uncertainty about getting the U.S.-Canada-Mexico Agreement ratified, the continuing U.S. tariffs on steel and aluminum and now China’s restrictions on Canadian canola are also contributing to a gloomy outlook for the economy here this year.

Internationally, the uncertainty over Britain leaving the European Union and the U.S.-China trade war are slowing global growth.

The spread between the U.S. Fed three-month and 10-year Treasury notes turned negative recently. That means the yield on a short-term note is higher than for long-term notes. That is a situation not seen since 2007 and often a sign that the economy is headed into recession.

But many of the U.S. Federal Reserve’s officials are saying they see the recent indicators of a slowing economy as fleeting and that the underlying American economy is strong.

Most central bankers are against back-tracking on the ground they have made toward restoring interest rates to an historically normal level. One reason is that they want room to manoeuvre and provide stimulus when the next recession ultimately does arrive. If rates were already near zero, there would be no room to cut them to stimulate the economy.

None of this gives me any solid conviction as to the direction of the value of the loonie, but it does seem clear that further interest rate increases are ruled out at least for the current year while all this uncertainty hangs over the economy.

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