The Poloz puzzle: Policy lauded, but message muddled

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Last winter, not long after Bank of Canada Governor Stephen Poloz stunned financial markets with an unexpected interest rate cut – perhaps the defining moment of his tenure as head of the central bank – he was asked whether he was enjoying his time in an economic hot seat that had just gotten considerably hotter. His response: "I'm loving it."

But after a trying 12 months in which the Canadian economy flirted with recession, and Mr. Poloz cut the bank's benchmark overnight rate twice and came close this week to a third cut, the love affair may have lost some of its lustre. Certainly Canada's economic and financial circles have developed a love-hate relationship with the personable but occasionally perplexing central bank chief.

From former senior central bankers to academics to Bay Street analysts, the general consensus is that Mr. Poloz has done a solid job steering Canada's monetary policy through a trying and uncertain year. They agree that the cut a year ago, which at the time confused and even angered market participants, proved a prescient and wise move. But many central bank watchers continue to struggle with the way Mr. Poloz and the bank communicate their message – and this week's announcement was no exception.

"I think there is a bit of a divergence between what Poloz is saying and what the market is thinking," says George Davis, chief fixed-income and currency analyst at RBC Dominion Securities. "There's a dose of skepticism about what the bank is pitching."

Experts credit Mr. Poloz for acting early with monetary stimulus at the first signs of oil shock trouble a year ago. At the time, some critics felt he had acted too rashly and hastily. But in hindsight, he is generally lauded for being ahead of the curve, given the rough year that unfolded since.

There are also many prominent supporters of his decision this week to hold the central bank's key rate steady at 0.5 per cent, despite a growing call from the markets ahead of the decision for a quarter-percentage-point cut, sparked by alarm over the deepening plunge of oil prices.

"I think the way that this has been set out, to me it looks like it's exactly the right analysis of the situation," says David Dodge, the Bank of Canada's governor from 2001 to 2008. "Let the exchange rate do what it's supposed to do, don't create any additional uncertainty around that [with a rate cut]."

At his post-announcement press conference, Mr. Poloz looked remarkably relaxed and confident, given that the hold-steady decision by the Governor and his council of deputies was, by all accounts, a nail-biter. (By contrast, he has often appeared in the past year popping throat lozenges and fighting a cold, perhaps a testament to how straining his job has been.) Nevertheless, some of what Mr. Poloz had to say raised as many questions for the market as it answered.

After long viewing Mr. Poloz as a proponent of weak-dollar policies (a characterization to which he has frequently objected), he suddenly sounds like he is willing to defend the Canadian dollar. That sparked a sharp turnaround in the currency; by the end of the week, the loonie was up more than 2 cents (U.S.) since the rate announcement, additionally aided by a rebound in oil prices.

There is now also a widespread belief that Mr. Poloz has essentially thrown down the gauntlet to Ottawa – all but declaring that monetary policy has gone as far as it's willing to go to stimulate the economy, and it's now time for fiscal policy, government spending, to take the reins. That's reading an awful lot into what Mr. Poloz actually said: That the bank hasn't incorporated the government's promised spending increase into its economic growth projections because it won't know the details of that spending until after the government presents its budget in the coming months; that this will improve the bank's growth projections when it happens; and that this was a factor in the bank holding off on another rate cut. Still, central-banking veterans noted, for the Bank of Canada to comment at all on the economic benefits of a not-yet-announced government spending stimulus was an unusual step into the fiscal sphere.

More significantly, many are puzzled by the bank's unexpectedly optimistic view of the economy that accompanied its rate decision, especially in light of oil's further downfall, as well as the marked deterioration of business sentiment in the bank's own Business Outlook Survey, released only days earlier. The bank forecast gross domestic product growth of 1.4 per cent this year even without incorporating the effects of government stimulus spending; several private sector forecasters believe growth won't be much more than 1 per cent, including the stimulus.

"We thought the accompanying statement would be dovish-leaning. That caught the market by surprise," Mr. Davis says.

Central-bank-speak has traditionally been like a code of meaningful words and phrases for investors to break, to unlock the bank's policy leanings and their market implications. Mr. Poloz has changed the Bank of Canada's approach to communicating its message, and in doing so has changed the code – much to the ongoing frustration of many market participants.

"The people on Bay Street have been annoyed," says economist Stephen Tapp, research director at the Institute for Research on Public Policy (IRPP).

Unlike his predecessors, who would use the text of the previous rate announcement as the template for the next one and change only a handful of words to signal subtle changes in their thinking, Mr. Poloz insists on starting each rate statement as a blank slate, telling, as he puts it, "a fresh story" every time. He argues that it makes for a better conversation. But it has complicated the task of interpretation for the country's trading desks.

"It's not as easy to read into the narrative. There's not the same flow," RBC's Mr. Davis says.

It also has meant that occasionally, the precision of the message leaves something to be desired. That came up again in this week's rate announcement.

The bank's formal statement announcing the decision, as well as in its more detailed quarterly Monetary Policy Report that was released at the same time, stated that the bank forecasts that Canada's output gap (the difference between actual output and the economy's full capacity, indicative of how far the economy is running below its potential) will close "around the end of 2017." But in his prepared opening statement at a press conference following the announcement, Mr. Poloz characterized the timing as "late 2017, perhaps later." Critics say the inconsistency creates uncertainty in the market and complicates investing decisions.

Steve Ambler, an economics professor at the Université du Québec à Montréal who sits on the C.D. Howe Institute's Monetary Policy Council (a shadow committee of leading monetary experts that mimics the Bank of Canada's deliberations and issues its own rate recommendations), says the bank's "communications issue" has come up repeatedly at meetings of the council.

"The more you can make your monetary policy forecastable, the more effective it will actually be. The current overnight rate has a pretty small overall impact on markets. What really matters is the path of the overnight rate, up to six to eight quarters down the road."

Cutting by one-quarter of a percentage point has a pretty minor impact, he says. "If you want to really have an impact, tell markets what direction you're going to go."

On the other hand, Mr. Poloz took the unusual step of disclosing that he and his colleagues had "a bias toward further monetary easing" when they began their deliberations a week before the rate decision, but talked themselves out of it. This was an unprecedented level of public candour for a central bank that doesn't even record minutes of the private deliberations of its decision-making leadership, let alone release them publicly. As he gets further into his tenure as bank chief, Mr. Poloz has become increasingly inclined to give us deeper glimpses into these back-room discussions, if only in relatively broad terms.

Communications issues aside, the bottom line for many observers is the Bank of Canada's success in guiding the economy back to health. In this week's announcement, Mr. Poloz and his team remain convinced that the economy can be back up to full speed within two years. The problem, critics point out, is that they have been saying that consistently ever since the Great Recession – yet every few months, the goal posts get moved further down the field.

Mr. Tapp of IRPP notes that because of the nature of Canada's monetary policy, which targets getting the economy back to full capacity and inflation stable at the 2-per-cent target typically within six to eight quarters, the bank has had a tendency to assume it will achieve those targets in the second year of its forecasts. Right now, the bank forecasts growth of just 1.4 per cent in 2016, but 2.4 per cent in 2017. A year ago, it predicted growth of 2.1 per cent for 2015 (it is now estimated at 1.2 per cent) and 2.4 per cent for 2016.

"There's always this assumption in Year Two that growth will accelerate. And it doesn't," Mr. Tapp says.

And there may lie the ultimate note of caution on reading Mr. Poloz's message.

"If someone tells you that we'll be back to full capacity in two years because the bank says we will, and so we don't need a rate cut, don't believe it. There have been seven years that it hasn't been true," Mr. Tapp adds.