LONDON, Ontario — The Bank of Canada’s surprise rate cut last month bought the central bank time to see how the economy responds to a plunge in oil prices, Governor Stephen Poloz said on Tuesday in the bank’s last pronouncement before its March 4 rate decision.
Poloz did not refer to next week’s announcement, saying only that the Jan. 21 cut was intended to take out insurance both against too-low inflation and against financial instability posed by high household debt. “The sudden drop in global oil prices has increased both risks,” he said in a speech.
Stressing uncertainty over the effects of cheap oil and over where oil prices are going, he said: “The downside risk insurance from the interest rate cut buys us some time to see how the economy actually responds.”
The market has priced in nearly a 75 percent chance of a rate cut on March 4, but Deputy Governor Agathe Cote was careful last week to say there was “no predetermined path” for the policy rate.
Poloz said the January cut gave the central bank greater confidence of a return to full capacity and stable inflation by the end of 2016, instead of sometime in 2017. It will also cushion the decline in income and employment, as well as the rise in the debt-to-income ratio, caused by lower oil prices.
“We are in a very uncertain setting, and what we are trying to do is to manage the risks we face, not eliminate them,” he said, in the speech at his alma mater, Western University.
Negative effects of lower oil prices hit the economy right away, he said. Positive effects, including more exports due to a stronger U.S. economy and lower dollar, and more consumption, will arrive only gradually and are of uncertain size.
With emergency monetary policies still in place in many economies, “we are still a long way from home and the headwinds are strong,” he said, adding the challenges were dissipating only gradually.
Poloz drew a number of lessons from the 2007-09 financial crisis and its aftermath, among them that while low and stable inflation is required to reach financial stability, it does not guarantee stability.
Another lesson is that while imbalances in general can make an economy vulnerable, “debt-fueled imbalances are particularly hazardous.” That’s because when a shock occurs, it can take a very long time for balance sheets to be repaired, he said.
© Thomson Reuters 2015
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