OTTAWA - Bank of Canada governor Mark Carney is expected to cut interest rates by half-a-percentage point Tuesday not because he has to, but because he can.
Talk of recession has subsided in Canada and the bank's overnight rate is already a toothless 3.5 per cent, helping to keep consumer demand reasonably robust.
Yet when the newly minted bank governor looks at the other side of the teeter-totter he must strive to keep on balance, Carney must wonder at his good fortune that the current global inflation bogeyman seems to have given Canada a miss.
Prices are rising by about eight per cent annually in China, four per cent in the U.S., 3.6 per cent in Europe. In Canada, not so much.
In fact, last week's Statistics Canada report saw the country's overall inflation dip for the fourth straight month to 1.4 per cent for March, hardly the stuff to induce palpitations even in an excitable central banker.
"I'm grudgingly calling for a 50 basis point (half point) drop on Tuesday, but I'm not convinced that is the right call,'' says Douglas Porter, deputy chief economist with the Bank of Montreal.
"There's lots of signs the economy is holding up. Auto sales look to have posted their strongest quarter on record, housing starts had their second best quarter in 20 years and more than 100,000 jobs were added. Even with the talk of the credit crunch, the reality is that overall household credit growth has simply not skipped a beat in Canada''.
"Carney himself hinted last week he was leaning toward making another bold move after a 50 basis point cut in January, saying he was worried that credit markets are tightening and saying he would make monetary policy ''on a forward-looking basis.''
" The explanation for Canada's incredible shrinking inflation story can be traced to two events that occurred last fall.''
The first was Finance Minister Jim Flaherty's unexpected one-point reduction in the GST, which Statistics Canada judges is likely shaving inflation by half-a-point and will do so throughout 2008.
Equally significant was the Canadian loonie's flight to parity last September. After much complaining, including a public rebuke from the finance minister, that retailers were not passing on the savings, consumers are now seeing discounts, sometimes deep price cuts, on many items.
Prices for automobiles, computers, televisions, clothing, books and even many foods have fallen in real terms in the past few months as pressure built on retailers to close the price gap wit the U.S. In March, the autos were 7.1 per cent cheaper than last year.
Food prices, which have risen sharply around the world causing food riots in some underdeveloped economies, have also been held in check by fierce competition among grocery chains. In addition, some credit Canada's marketing boards with a minor role on keeping prices steady on some foods, particularly dairy products.
"The strong dollar has made a big difference for Canada,'' said Global Insight's Dale Orr. "Of course the euro has also appreciated, but Europe doesn't import as much from the U.S. as Canada does so it hasn't had the same impact on inflation there.
"Even oil hasn't gone up nearly as much in terms of the Canadian dollar as it has in the U.S.,'' he added.
The two big deflationary factors will keep prices under control in Canada the rest of the year and Orr believes inflation won't be a problem for the next two years as well.
Although the case for chopping interest rates is not as compelling as it is in the U.S., where the economy is in or nearing recession, CIBC senior economist Avery Shenfeld nevertheless believes lower rates in Canada are a no-lose proposition.
The central bank's overnight rate may be low, but he agreed with Carney that tight credit conditions has pushed the actual cost of borrowing significantly higher, meaning the bank needs to cut deeper to produce a stimulus effect. The other compelling reason, he adds, is the U.S. recession.
"It's a case where there's little likelihood of harm if you cut rates aggressively, and much more likely you would regret not doing so if the U.S. recession lingers,'' Shenfeld said.
The danger is overshooting and the impact down the road. Canada's central bank has already sliced rates by one percentage point since last fall, and many economists believe it won't stop until it has brought the overnight rate to 2.75 per cent, which could build in inflationary pressures that surface with a vengeance in 2008.
"The recent good news on inflation may prove to be a one-off bonus from the loonie's trip to parity and could be reversed as wage pressures continue to mount and if the global commodity prices continue to soar,'' said Porter.
But that is unlikely to prove a decisive factor Tuesday, added Orr. Carney can't afford to be caught on the sidelines when the U.S. Federal Reserve cuts rates the following week, he said. And then, there's the fact that unlike many other central bankers, Carney can.
