TORONTO (Reuters) - The Bank of Canada has more than a credibility problem. It also has an effectiveness problem. With interest rates already at record lows, Wednesday’s interest rate cut or any further easing will have little impact given borrowers are already leveraged to the hilt.
And much like his peers in industrial economies around the world, Governor Stephen Poloz has few tools left in his kit.
After weathering a global malaise better than most countries, Canada is now teetering on the brink of a recession, sideswiped by a long plunge in oil prices and a long wait for main trading partners to start buying Canadian exports again.
“So much of this depends on events outside of Canada, and is inherently unpredictable, (that) it makes the Bank of Canada look bad. It makes the Bank of Canada seem ineffective. And the fact is, they are ineffective,” said Sherry Cooper, chief economist at Dominion Lending Centres.
Poloz took pains on Wednesday to assure Canadians the central bank still had plenty of ammunition after it cut the benchmark rate by quarter point to 0.50 percent. Economists say, however, most of the options offer diminishing returns and little bang for the buck.
“There is a phrase, ‘pushing on a string,’” said Hilliard MacBeth, a portfolio manager at RichardsonGMP in Edmonton.
“You get to the point where the Bank of Canada tries to cut rates and put more money in the system, but at the other end of the funnel, people have to be willing and able to borrow ... and a lot of people are at the maximum they can qualify for. It doesn’t matter how low rates go at that point.”
The Bank can cut rates a bit further, taking them closer to zero. But with the United States heading for tightening, such a move will hammer the Canadian dollar. That is good for exports, but more expensive imports hurt the same consumers Poloz wants to encourage.
The central bank could also resume issuing forward guidance to markets about future interest rates, a tool first introduced by his predecessor Mark Carney, now Bank of England governor. That, Poloz has said, is best saved for times of crisis because it removes needed volatility from markets.
But without such guidance markets have often been at a loss with investors criticizing Poloz for sending mixed messages.
“The bank has had trouble in their communication since the end of December,” said Darcy Briggs, portfolio manager at Franklin Bissett Core Plus Bond Fund.
“From housing concerns in December to a surprise cut in January. To, ‘We’ve taken out the right amount of insurance,’ to ‘Q1 doesn’t look so good.’ To, ‘Everything is okay,’ in April. The message has not been consistent.”
The central bank can also ease monetary policy by either raising its inflation target - effectively promising rates will stay low for longer - or by buying some of the debt obligations in Canada in exchange for cash.
At first sight, there is a lot of room for such purchases given the bank’s balance sheet was C$95.851 billion on June 30, or only 4.8 percent of Canada’s GDP.
By comparison, the U.S. Federal Reserve’s balance sheet has ballooned as a result of its debt buying program to $4.48 trillion on July 1, 2015, or 25.3 percent of GDP.
Skeptics doubt though whether any of that will work, arguing that Canadian consumers and companies have already easy access to cheap and ample funds and what the economy needs is more buyers for its exports.
While the rate cut lowered the value of the Canadian dollar, making its exports cheaper, top trading partners, such as the United States and China are not growing strongly enough to provide the demand Canada needs.
“What’s left really is the dollar, and yes you may get a cent out of the dollar, but I don’t think this will make a big difference,” said Benjamin Tal, senior economist at CIBC World Markets.
“The Bank of Canada really does not have enough power to change things ... and is becoming less and less effective with every cut in interest rates.”
Another reason why rate cuts are no longer effective in stimulating demand is that Canada’s big banks are no longer willing to pass on all of the cut to their customers.
With housing prices near record highs and many prime borrowers already highly leveraged, a rate cut may matter only to Canada’s relatively small subprime market, said Tal.
“That’s where every basis point counts,” said Tal.
“Ironically, we will be stimulating a place where we don’t want to stimulate - subprime borrowing.”
Additional reporting by Randall Palmer in Ottawa and Solarina Ho in Toronto; Editing by Tomasz Janowski