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Bank of Canada, BMO in rare ‘failure to communicate’ over run-up to rate hike
Michael Babad

This article was published more than 6 years ago. Some information may no longer be current.

Briefing highlights

  • BoC, BMO in spat
  • Markets at a glance
  • What to watch for in debt report
  • What to expect in housing report
  • What else to watch for this week
  • Alamos Gold to acquire Richmont Mines
  • China relaxes yuan hedging rules
  • Housing starts speed up

The Bank of Canada and one of the country's leading commercial banks are caught up in what can only be described as a rare failure to communicate.

This began when Bank of Montreal's chief economist, Douglas Porter, rapped the central bank on Friday for what he called faulty communications in the run-up to last week's second interest rate hike. Actually, he faulted the central bank for no communication.

The Bank of Canada responded Sunday with a spirited and lengthy defence of its actions, saying many markets players were not caught off-guard when it raised its benchmark overnight rate by one-quarter of a percentage point, to 1 per cent, last Wednesday.

And it wasn't at all off-base in its communications approach, said spokesman Jeremy Harrison.

Mr. Porter criticized the central bank in his report for what he said were eight weeks of silence before the rate hike and accompanying policy statement, which drove the Canadian dollar up sharply.

Mr. Porter compared what happened to the frequency with which members of the Federal Open Market Committee, the Federal Reserve's policy-making group, are out in front of the public, giving speeches or making comments at conferences.

"Ahead of every FOMC meeting, we are asked to grade the Fed's communications policy since the prior meeting," Mr. Porter said.

"On the Bank of Canada, many would be tempted to give them an F in this case," he added.

"We think that harsh judgement is wrong – we would give them a zero. As in, there was no communication since the last meeting. Zilch. Zip. Nada. Nothing."

Notable here is that some economists changed their view just before the central bank meeting, when Statistics Canada reported that second-quarter economic growth was far stronger than expected, with gross domestic product expanding at an annual pace of 4.5 per cent.

After that reading, some observers still believed the Bank of Canada would wait until October to raise its key rate, while others expected what, in fact, occurred.

Indeed, the central bank took note of this in its response.

"Although Mr. Porter indicates that only six of 33 forecasters anticipated the bank's rate increase [last] week, market data indicated roughly 50-50 odds of an increase prior to the announcement," Mr. Harrison said.

"Evidently, a much higher percentage of trading desks were correctly interpreting the bank's prior messaging that monetary policy would be forward-looking and data-dependent, not predetermined. Markets took on board the string of positive surprises in the economic data, especially the Q2 GDP report on Aug. 31."

The central bank has a "blackout" period during which it won't comment. That runs for one week ahead of a decision, and, in this case, the GDP report came during that period.

"The most significant piece of incoming data between the July and September decisions - Q2 GDP - was published on 31 August, inside the bank's pre-decision blackout period," Mr. Harrison said.

"The significance of a Q2 annualized growth rate of 4.5 per cent, much stronger than the bank's July projected estimate of 3 per cent, appeared clear to financial markets, with expectations for a September rate rise increasing in the days after its publication, and prior to the bank's Sept. 6 decision," he added.

The rate hike this time out was certainly much different than the previous one in July, when policy makers were front and centre, signalling their intentions with a market shift in tone.

They included both governor Stephen Poloz and senior deputy Carolyn Wilkins, and markets certainly took note.

Not this time.

"As per Cool Hand Luke, what we had here was a failure to communicate – an epic fail," Mr. Porter said.

"And that's just not on," he added.

"On some occasions, we will hear from three [Federal Reserve] speakers in a day. We didn't hear a peep from the bank for eight weeks. And the reality is that this vacuum created a great deal of uncertainty in markets ahead of the rate decision, and a fairly violent market reaction in its wake. And it's not the first time we've seen abrupt market moves surrounding BoC meetings."

Mr. Porter, by the way, wasn't quibbling with the rate hike. He believed it was due.

He also noted that Mr. Poloz "has openly stated he prefers two-way markets to keep them guessing, and so a lot of forecasters are going to get it wrong a lot of the time."

Bank of Canada Governor Stephen Poloz takes part in a news conference in Ottawa, Ontario, Canada, July 12, 2017

Regardless of what market players were expecting, Mr. Harrison noted that the Bank of Canada doesn't normally speak publicly in late summer, between its monetary policy report in July and its rate setting in early September.

"This has been the case three out of the past four years," he said.

Also important, he added, is that the central bank said in July that future decisions would depend on indicators, which would have included the surprise GDP report.

Mr. Harrison stressed several other comments made by Mr. Poloz at his last outing in July, including that "the economy was absorbing excess capacity more rapidly than projected," that "additional capacity could be created" as growth exceeds potential, that "the appropriate setting for interest rates when economic growth is rapid, but inflation is low is an important issue," and that future rate changes "must be sensitive to continued uncertainty and financial system vulnerabilities."

"All of these issues remained relevant between the July and September decisions and were referenced in the September statement," Mr. Harrison said, noting that Mr. Poloz said in July that low inflation was the result of temporary factors, and in fact has since ticked up.

How central bankers communicate is no small matter, given how they can move markets, and some players are now trying to interpret last week's policy statement and redraw their rate-hike forecasts.

Avery Shenfeld, for one, believes markets are misinterpreting parts of last week's statement, which can lead to possibly unwarranted market gyrations.

Mr. Shenfeld, chief economist at CIBC World Markets, who actually had predicted a rate hike last week, noted how many market players now expect still another increase this year.

"Poloz's team pointed to the fact that monetary policy still was delivering 'considerable' stimulus," Mr. Shenfeld said.

"Since it was followed by a sentence saying that further tightening isn't 'predetermined,' it was likely aimed at justifying a September hike that came with inflation still below target, by suggesting that the economy can easily live with higher borrowing costs," he added.

"Instead, the market took it as a sign that the bank was in a hurry to get rid of even more of that existing stimulus."

Traders, he said, also keyed on the central bank's comments on the appreciating loonie, also an incorrect interpretation.

The policy statement said the currency's gains reflect the strength of Canada's economy, which markets read "as implying that the loonie's sharp rise was of no concern to the Bank of Canada, and not a barrier to another hike this year," Mr. Shenfeld said.

"No wonder it jumped more than a cent after the announcement," he added.

"But note that the statement's prior line explained that global developments had led to 'a weaker U.S. dollar against many major currencies.' So some of the loonie's appreciation is an exogenous event that represents a net drag on Canadian export growth and inflation ahead. The statement should have said so explicitly. If it were largely Canadian fundamentals, where is Canada's big trade surplus?"

Mr. Shenfeld believes the central bank may clarify its remarks either ahead of, or in, its October statement so it can "dampen expectations for how quickly the next hike will come."

That's some time from now, though. And BMO's Mr. Porter noted that the Bank of Canada's goal is to target annual inflation – at 2 per cent – to "give more certainty" so businesses and the rest of us can plan ahead.

"Well, are interest rates and the exchange rate not also crucial contributors to any planning decisions that businesses and households need to make?" Mr. Porter said.

"A good case can be made that a 13-per-cent swing in the exchange rate and/or an 80-basis-point spike in two-year yields in a four-month period (which we have just seen) is a much bigger deal for business than whether the inflation rate is a few ticks above or below the 2-per-cent target," he added.

"True, the bank can't control volatile [foreign exchange] markets, but at least they can avoid intensifying the volatility."

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Markets at a glance

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What to watch for this week

No, we're not expecting any comments from the Bank of Canada, though there's still plenty to chew on.

From inflation to housing to consumer debt.

We'll have to wait until the end of the week to find out just how much we owe. And I'm hardly going out on a limb here in projecting that it's a whopper.

Statistics Canada releases its second-quarter report on wealth and debt Friday morning, the latter being the focus.

And what anyone who hasn't been living on a deserted island knows, Canada is notable for its record household debt burden.

(And even those on deserted Canadian islands probably borrowed big time to finance their huts.)

"Attention on this release is largely focused on the debt-to-income ratio, which we expect to rise 0.7 of a percentage point to 167.6 per cent in Q2 as the pace of debt accumulation exceeded the growth in personal disposable income in the quarter," economists at Royal Bank of Canada said in a lookahead to the report, noting that the numbers pre-date the central bank's recent rate hikes.

Benjamin Reitzes, BMO's Canadian rates and macro strategist, also sees that key debt measure coming in at a record level.

"While housing in southern Ontario is cooling now, it was still red hot in Q2, and that drove solid increases in mortgage lending," Mr. Reitzes said.

"Note that Q2 usually sees the biggest seasonal increase in the debt ratio, with gains of at least 0.9 of a percentage point every year since 2001," he added.

"Fortunately, income growth was very strong in the quarter so that should provide some offset. Expect the persistent march higher in the debt ratio to slow sharply in [the second half of the year] as housing cools and the BoC pushes rates higher."

That's one side of the coin. Mr. Reitzes also expects the report to show that net worth as a share of disposable income also hit a fresh high amid surging house prices. Of course, lagging Toronto-listed stocks wouldn't have fed into that, he noted.

"Over all, Canadian balance sheets are in decent shape, despite persistent concerns. The question now is how sensitive are households to higher rates? We'll find out with the BoC's surprisingly aggressive policy shift."

The rest of the calendar:

Tuesday

The big scheduled event of the day is an announcement from Apple Inc., which is expected to unveil the iPhone 8 and other goodies.

Citigroup analyst Jim Suva expects a "major design overhaul" on this, the 10-year anniversary of the wildly popular smartphone.

"We expect this premium iPhone 8 OLED version to have a retail ASP of $1,000," Mr. Suva said, referring to organic light-emitting diode and average sales price.

"Key items to look for are: OLED display, facial recognition, 3-D sensor (enabling augmented reality) and wireless charging along with faster processor, improved battery life and increased memory."

There's little on the North American economic schedule, but markets will get to see how consumer prices in Britain behaved. RBC believes annual inflation rose in August, to 2.8 per cent from 2.6 per cent.

"This reflects the ongoing impact of exchange rate depreciation associated with the EU referendum feeding through to higher import prices," the bank said.

Wednesday

First, Britain's up again, this time with an employment report expected to show the jobless rate holding at 4.4 per cent, or inching down to 4.3 per cent.

That will be followed in Canada in the morning with the latest reading of the Teranet-National Bank home price index.

Thursday

Another inflation reading, this one from the U.S., where Hurricane Harvey left its mark.

"We expect headline CPI inflation to pick up to 1.9 per cent year over year in August, with prices up 0.4 per cent month over month," said Toronto-Dominion Bank economists.

"Energy prices will be a significant boost this month following Hurricane Harvey, which shuttered about a quarter of the nation's refinery output."

Bank of England governor Mark Carney – he used to be ours – takes centre stage with his colleagues, and is expected to hold the key rate at 0.25 per cent.

On the corporate side, investors will also see the latest quarterly results from Empire Co. and Oracle Corp.

Friday

Besides learning how much debt we're juggling, we'll also see where much of that borrowed money is going, as the Canadian Real Estate Association reports August home sales and prices.

Already having seen some regional reports, BMO expects to see sales down 8 per cent from a year earlier, and the MLS home price index rising at a slower pace of 11 per cent.

(I know, right? Slower, but still 11 per cent. Consider, though, that that would mark the slowest so far this year, down from almost 13 per cent in July and almost 20 per cent from the April peak.)

"The housing story continues to vary across the country," said BMO's Mr. Reitzes.

"Sales continue to fall in southern Ontario as the impact of the new housing measures put in place in late April ripple through the market," he added.

"Meantime, B.C.'s market is in recovery mode, with Vancouver sales up about 20 per cent year over year, led by townhomes and condos. Activity remains solid, if unspectacular, in Ottawa and Montreal, while the Prairies are mixed, with Edmonton and Saskatoon struggling and Calgary seeing modest gains."

The week also closes with a look at August retail sales in the U.S., expected to show little change and possibly a tiny dip.

"The outlook for retail sales in August has become clouded by the effects of Hurricane Harvey," said Royce Mendes of CIBC.

"Unit auto sales showed a drop during the month, at least partially tied to dealers in hard-hit areas," he added, noting that the bump in gasoline prices will buoy the headline number.

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