Bank of Canada interest rate outlook; Consumer confidence in the dumps

Bank of Canada rate outlook

The structural issues with Canada’s miraculous economic growth coming out of the recession has been painfully obvious to me for some time now.  When one strips away the economic spin-offs of rising home prices and the associated wealth effect spending, inventory restocking by businesses, and stimulus spending by government, we find our growth miracle was largely a mirage.

The unsustainability of this growth illusion should be clear to my readers.  An economic bounce fueled by an expansion in already-stretched consumer credit and government spending is not the start of a protracted period of economic bliss.  At best it temporarily papers over the structural weaknesses.  At worst, it magnifies them.

Being fairly obvious to me, I went out on a limb and predicted several times that the BoC would not raise interest rates.  This prediction was not made on the basis of what I thought the BoC should do, but rather what I anticipated Carney would do given the response of most central bankers, who seem to all play by the same rulebook.  I was twice proven wrong earlier this year.  My pride being battered, I take some solace in the fact that most economists are starting to see things my way.

If we rewind back to late 2009 and early 2010, at a time when I was predicting a long stretch of record low interest rates, the consensus among the big banks was that interest rates would hit 2% to 2.5% by early 2011.

Today we see that the ‘unexpected’ weakness in our economy has resulted in the big bank economists removing their rose-coloured glasses:

Dismal trade outlook, housing weakness point to rate hikes on hold

“…Observers are quietly resigned to the fact that on Tuesday central bank governor Mark Carney will hold rates as they are and will likely continue to do so for at least the next few months.

The broad conviction stems from a host of recent data showing the economy slowing to a crawl — most recently in terms of growth, now a paltry one per cent, and the labour market, which has been coughing out an average of 4,000 jobs a month, compared to a 75,000-a-month average earlier in the year.

“There is no disagreement that the bank will keep its overnight lending rate unchanged at 1.0 per cent as it chose to do in October following a string of three 25 basis point rate hikes this summer,” said BMO Capital Markets deputy chief economist Douglas Porter.”

That makes me feel at least somewhat vindicated.  But where do things go from here?  Well, we know that consumer credit must slow at some point.  It is pushing 150% of disposable income, an all-time high.  That part is indisputable.  What the reversion back to the mean will look like is the only question.

My contention is that most people in a society overwhelmingly think as a collective.  Once it becomes apparent to some that their consumption-driven lifestyle is in fact damaging to their long-term financial health, it will likely become obvious to many.  I’d suggest that we are very near that epiphany moment.

When that moment is reached and people suddenly realize that they have too much debt and too little savings, the inevitable reversion will have some predictable consequences:  It will constrict both consumer spending (+65% of GDP) and it will slow demand for housing.  House prices will fall, which we know will choke off HELOC growth, which added over 8% to household income in the past year.  The net result will be a marked slowing of Canada’s economy and a likely recession by late 2011 if my time line is correct.

It would take a central banker with extreme integrity and nerves of steel to raise rates in that environment.  As much as I believe it is necessary for the long-term health of the country, I just don’t see it happening.

My prediction stands:  We will again see emergency low interest rates before we see a serious round of rate hikes that brings us back to historical norms.

Consumer confidence in the dumps

Despite some recent month-over-month improvements, the overall reading in consumer confidence as measured by the Conference Board of Canada remains well below pre-recession levels….hardly indicative of a new phase of economic expansion.

The Conference Board data provides some predictive value in determining the future direction of consumer spending:

“As it did in each of the two previous months, the balance of opinion on major purchases worsened. Consumers are asked if they feel now is a good time to make a major purchase—such as a car, home, or major appliance. This month, 41.2 per cent responded that it was, a 0.2 point increase. Unfortunately, the share who said that it was a bad time rose even more—up 0.7 percentage points—to 48.6 per cent.”

A new poll by the Institute for Research on Public Policy may provide some insight into how consumer confidence and consumer perceptions may shape the political climate in the not-to-distant future.  I have been arguing for some time now that austerity is coming to most of the Western world, Canada included.  I have argued that it will either be forced on us or embraced by us.  The recent unlikely victory by conservative leaning Rob Ford in the predominantly left-leaning Toronto tells volumes.  Even more telling is the fact that Ford tapped into consumer anger using a campaign line of “Stop the Gravy Train”.

The new poll data has found that some measures of consumer confidence are back to the levels seen during the credit crisis of 2008.

The Canada “right direction” number is 52.2 percent — almost identical to the 53.6 percent we found in 2008 — but that was in different economic circumstances following the crash of the stock market and the start of the worst synchronized global recession in 60 years.”

“While Canada has come out of the recession in better shape than any of its G7 partners, the weaker “right direction” numbers indicate a lack of confidence in the recovery and a growing malaise, despite six consecutive quarters of economic and employment growth.”

Perhaps people are sensing that the ‘growth’ is in fact illusory, backed overwhelmingly by an unsustainable run-up in credit.

I don’t often comment on politics, though I will chime in on this one.  Of far more interest to political watchers is the implications of this reading for the Harper government in the next election.  While I cannot prove it decisively, I will suggest that the discontent that the electorate feel with Stephen Harper is largely rooted in its own ‘conservative’ support base.  The largest peace-time deficit has been spent to create a rapidly-fading economic bounce.  Against this backdrop, it’s exceptionally difficult to label Harper a ‘conservative’.  I think people are starting to get that.

There is a secular shift coming that will alter the way our society feels about consumption, credit, and what it means to have a ‘comfortable’ lifestyle.  Our perception of entitlement programs will shift with it, as will the collective political leaning.  True fiscal conservatives will reign.  Mark my words.  The only question is how close we are to that secular shift, and who will step up with the integrity to lead in that climate.

It certainly won’t be Mr. Harper.



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8 Responses to Bank of Canada interest rate outlook; Consumer confidence in the dumps

  1. Don says:

    Who has been calling for a rate increase?

  2. mac says:

    A China bubble article that supports your views:

    And also gives an inkling into mine. Consider that house prices in Vancouver are not the highest in the world:

    “Prices are 22 times disposable income in Beijing, and 18 times in Shenzen, compared to eight in Tokyo. The US bubble peaked at 6.4 and has since dropped 4.7. The price-to-rent ratio in China’s eastern cities has risen by over 200pc since 2004.”

    Consider why certain Chinese want their families and money out of China and somewhere “safe”, protected and familiar like Vancouver:

    “On a recent visit to a chemical plant in Suzhou, I was told by the English manager that wage bonuses for staff will average nine months pay this year. This is what it costs to keep skilled workers. His own contract is fixed in sterling, which has crashed against the yuan over the last two years. “It is a sobering experience,” he said.”


    “If there is a hard-landing in 2011, China’s reserves of $2.6 trillion – or over $3 trillion if counted fully – will not help much. Professor Michael Pettis from Beijing University says the money cannot be used internally in the economy.”

    Maybe many of the many Chinese millionaires and billionaires read Chanos.

  3. John in Ottawa says:

    I can think of a dozen reasons, off the top of my head, why I would like to see Harper gone, but his handling of the economy isn’t one of them.

    Going back a couple of years and looking forward, what should Harper have done differently, particularly in light of the compromises that minority governments have to make?

    The “book” says that when a recession starts the government should take up the slack with stimulus spending. This recession started hard and fast and all governments flooded their economies with stimulus. Putting banksters aside, the goal of the stimulus was to mitigate unemployment. It is hard to pinpoint just how successful governments were (Bernanke says US unemployment would have reached 25%…who knows), but let’s say they were moderately successful.

    The “book” would also suggest that the recession should be only as long as it takes to unwind excess capacity. This recession, by some measures, has been over for a year, but there is still lots of excess capacity and unemployment has not recovered.

    Now most governments, Canada included, are throwing away the book and withdrawing stimulus even though employment has not recovered. We hear of austerity everywhere.

    Carney has tapped on the brakes a couple of time in an attempt to slow down the personal debt bubble. Harper is freezing federal program budgets and government departments are going through “internal service reviews” and “work force adjustment.” Euphemisms for layoffs and down sizing.

    Liberals want to let everyone out of prison, Conservatives want to put everyone in prison. Liberals want to take away all the guns, Conservatives want a gun on every living room wall. There are lots of policy differences between Liberals and Conservatives except when it comes to the economy.

    Remember when Chretien was waving his Red Book around saying he would withdraw from NAFTA and abolish the GST? Did it happen? Could it happen? No on both counts.

    The economies of nations are too interwoven and codified by international treaty for governments to do what they please (unless you are the reserve currency). Look at the situation in Ireland. Today they will pass a very unpopular budget (I wish they wouldn’t) and in January the government will go down to defeat. However, the new government won’t repeal the budget unless it is committed to Ireland standing alone out in the cold.

    We tend to throw governments out over the economy and elect new governments based on their economic promises, and then forget that nothing actually changes. We’re a small part of a global economy and we have to follow the global play book.

    We’ll still be discussing the ongoing financial crisis years from now. Changing governments won’t do one bit of good.

    • I agree with just about everything you say, John. My issue with the Harper government is that they have proven to be borrow-and-spenders in fiscal conservative clothing. Remember that Mr. Harper is the same guy who headed the National Citizen Coalition. What ever happened to that guy?

      I think you are absolutely correct that they were largely forced to initiate the massive stimulus program because of their minority standing, but to call themselves conservatives in light of it is a bit ridiculous.

      They may well run a different ship if they get their majority government. My point is that their best chance of achieving that is to run on a ‘true’ conservative platform.

  4. rp1 says:

    We are not too far off that forecast and cpi is at 2.4%. It has been going up for a year:

    Another nice page to watch is this:

    The credit bubble may pop next year, but it hasn’t yet. Household credit is still increasing at a pace faster than the 1990’s. With sufficient inflation and low enough interest rates, this can continue.

    The question is, to what degree will the bank ignore its inflation target? If cpi is 3.5-4% will they raise rates? I think so. Undershooting now means overshooting later, and everyone knows Canadians have way too much debt. A bit of extra inflation isn’t going to fix it, so the only thing Carney can do that will not have everybody screaming is to broadly stick to the target and provide guidance. To his credit, he has been warning for a year about taking on excess debt.

    I think the forecast is a little early, but not fundamentally off. Nothing can save the housing market at this point, I think people are done buying. Lean years ahead.

  5. ATP says:

    The bigger problem is the lack of a national consciousness on the future direction of the nation. I do not see any meaningful initiative at any level, especially within the government, to start a serious dialogue on structural challenges we face: a rapidly aging population, a dying industrial base, our over indebtedness … We really need to pull our head out of the sand and quit patting ourselves on the back.

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