Unwilling to change interest rates, Carney uses language to impact economy

OTTAWA - Unwilling to cut interest rates to help restart the stalled economy, the Bank of Canada may seek to achieve the same end result Wednesday by continuing to soften its tone over future intentions.

Economists say financial markets are looking for a dovish statement — from a modest tweak of the bank's forward-looking guidance to dropping altogether the tightening bias on future rate hikes that has been on the books for about a year.

That would likely add more downward pressure on an already falling Canadian dollar, something they say would suit the bank's purposes nicely, both on the economic growth front and on its inflation mandate.

"A lower dollar would be consistent with what the bank is trying to achieve, " said Derek Burleton, a senior economist with TD Bank.

"A lower dollar not only helps to strengthen the economy, but also would help the bank to achieve its medium-term inflation targets. That's a positive offshoot of softer language."

A lower currency helps bolster one of the economy's weak points — exports — while at the same time boosting inflation, which at 0.5 per cent is well below the bank's one-to-three per cent comfort zone, by increasing prices on imports.

Analysts say the bank's policy panel won't be taking any concrete action on interest rates.

The bank has kept the overnight rate at one per cent since September of 2010 — a remarkable two-and-a-half year stretch of inactivity — and the betting now is it might stay there until the latter half of 2014.

But that doesn't mean governor Mark Carney is powerless to influence markets, and even real-world interest rates.

The outgoing governor, who has one more rate announcement to make before departing for the Bank of England this summer, has already made use of the power of words to achieve some real-life results in an effort to buck up the lacklustre economy, analysts say.

Since December, he has issued three dovish reports, the most dramatic coming in January when he surprised markets by declaring the prospects of a policy interest rate hike was now "less imminent."

Along with the weaker-than-expected economy which grew a snails-pace at 0.7 per cent in the second half of 2012, the statement likely contributed to a sharp drop in the value of the Canadian dollar from close to US$1.02 at the beginning of the year to the current level of just above 97 cents.

As well, bond yields have continued to weaken, with one factor being the recent announcement by the Bank of Montreal that it would lower its posted rate on five-year fixed mortgages to 2.99 per cent.

Scotiabank economist Derek Holt said he believes Carney will stop short of softening further what is already an extremely dovish guidance, but predicted the governor would point to weaker global economic conditions, as well as the spending cuts in the United States, to make the same point.

As for a rate cut, which markets have begun pricing in for later in 2013, Holt believes the bank will "go down fighting" rather than succumb to market pressure given that it has sunk so much political capital into lecturing people about the dangers of borrowing.

"I think they are much more likely to coax the markets into doing their easing on their behalf instead of changing the administered overnight rate," he explained. "They do that by talking more dovish, talking up a longer pause and exerting the Bank of Canada's influence further up the yield curve and in favour of a weaker Canadian dollar."

Ironically, Holt says the markets may actually strengthen the Canadian dollar Wednesday if Carney's language is not as dovish as they expect. But he believes the overall pressure on the dollar is downward.

"In terms of near term momentum, you could get the Canadian dollar coming off (to 90-95 cents US)," he says. "Probably every dealer is fielding a rising number of accounts about the 'shine-off-Canada' argument, and what's going on in our housing markets and the extent to which growth has been disappointing. They are questioning the whole Canadian resiliency story in a way I haven't seen since the depth of the crisis."

However, judging from Carney's statements two weeks ago, he believes the current soft patch in the Canadian economy is temporary, which suggests he will wait out the storm rather than change course dramatically. He cited the need not to "over-emphasize shorter-term data," and blamed a poor export performance for weaker than expected growth.

For the first three months of 2013, the bank has pencilled in a 2.3 per cent growth rate.

Economists say that is unlikely given the clumsy handoff from December, but most believe it will be stronger than the fourth quarter's 0.6 per cent.

In a new forecast, CIBC chief economist Avery Shenfeld says there is reason to be more optimistic going forward. He says the first quarter may actually see growth return to about two per cent, the believed cruising speed of the economy.

Employment dropped in January, but total hours worked rose by 0.2 per cent, indicating increased production. And auto sales, a signal of consumer confidence, appear to have rebounded. Exports also appear to set for a modest rebound after a disastrous 2012 as the U.S. economy firms.