Bank of Canada expected to hold rates amid energy uncertainty
Plunging automobile sales add to evidence that higher borrowing costs are beginning to eat into Canadian economic growth, possibly faster than the central bank expected.
Light vehicle sales dropped 9.4 per cent in November from a year earlier, the most since 2009, according to a report Monday by DesRosiers Automotive Consultants Inc. Outside the financial crisis, the decline was the biggest since 2004. Meanwhile, Bank of Canada data show growth in residential mortgages decelerated to 1.38 per cent in September on an annualized three-month basis, the weakest pace since 1982.
The central bank has raised borrowing costs five times since July 2017. Policy makers are widely expected to leave the benchmark rate on hold Wednesday at 1.75 per cent, however more hikes are predicted for next year. The median forecast in a Bloomberg survey of economists shows the rate at 2.5 per cent by the end of 2019.
Royce Mendes warns the economy is already feeling the pain, and the central bank may be underestimating the impact of previous increases. The Canadian Imperial Bank of Commerce economist said declines in auto sales and residential investment -- which contracted for a third-straight quarter, down an annualized 5.9 per cent -- are showing up sooner than expected, with the bulk of the effects still to come.
“We’re starting to the signs that the economy cannot handle interest rates at much higher than current levels,” Mendes said by phone from Toronto. “Things are happening at least a little sooner versus previous cycles” because of how leveraged households are, he said.
The relative importance of residential investment and vehicle purchases -- two of the most rate-sensitive sectors -- has grown over the years. The sectors now account for more than 11 per cent of the economy, versus 9.7 per cent when the last major tightening cycle began in 2004, and an average of about 9 per cent since 1961, according to CIBC calculations.
Even with the drop in car sales in November, 2018 is on pace to be the second-highest on record. That makes sense, given interest rates are still close to historical lows, and population growth is fueling an upward trajectory in the level of sales -- a trend that’s been in place since the 1940s.
Canada’s housing market, meanwhile, has slowed since the latest rate hikes began, a period that coincides with changes to mortgage-lending rules by the country’s banking regulator. While it’s difficult to determine how much of the slowdown is attributable just to higher rates, based on previous estimates of how much the rule changes alone would account for, “the slowdown in lending has been more precipitous,” Mendes said.
Governor Stephen Poloz said at the end of October rates would need to rise to a neutral stance, or somewhere between 2.5 per cent and 3.5 per cent. He told lawmakers the central bank wants Canadians to understand that 3 per cent would be just a “normal thing,” and it “shouldn’t feel difficult.”
But the latest data may give Poloz pause. “It means for the Bank of Canada that they’re not going to be able to make good on their stated desire to get to the 3 per cent neutral rate,” Mendes said, adding he expects a “softer tone” from the governor on Wednesday.
“The key point is that we haven’t seen the full effects of even the past interest rate hikes,” Mendes said. “We’re barely getting to peak impact of the first interest rate hike taken out in July 2017. All those subsequent hikes still have time to work their way through the economy and show up in slower growth.”
--With assistance from Erik Hertzberg