OTTAWA (Reuters) - Bank of Canada Governor Stephen Poloz’s shock rate cut on Wednesday sent a clear message to financial markets: Don’t expect me to hold your hand.
Trading floors reacted by selling the Canadian dollar and uttering more than the usual number of expletives, but the move drove home that the central bank has changed its views about a monetary policy tool used by Poloz’s predecessor Mark Carney, who’s now Governor of the Bank of England.
Since taking control of the central bank in 2013, Poloz has opted for a combination of folksiness - comparing the economy to bubbling spaghetti sauce and the currency to a dog on a leash - with traditional central bank ambiguity.
This was a contrast to Carney’s efforts to set explicit guidelines on where interest rates are headed.
“The fact that there was zero signaling ahead of it, and there was zero people expecting it because there was zero signaling, was quite odd for any central bank really,” said Greg Moore, senior currency strategist at RBC Capital Markets.
Some market participants say the rationale for the cut is understandable given oil’s steep descent. Poloz made clear in October he wasn’t in favor of providing explicit guidance to markets, when he abandoned a policy of indicating where rates were headed.
He told Reuters then that telegraphing an imminent change in interest rates would not be necessary “because the market will know.”
On Wednesday, Poloz said the ingredients were out there for the market to see a cut was coming. But market participants taken by surprise beg to differ.
“He (Poloz) is driving with the headlights off to some degree,” said National Bank Financial managing director of foreign exchange Jack Spitz. “They don’t want to be seen as being behind the curve, but this is very much ahead of the curve, so much so that the market had not even priced it in.”
The Canadian dollar retreated almost 2 percent to a nearly six-year low.
Some market players said they think Poloz, formerly head of Export Development Canada, wants a weak Canadian dollar to help drive exports. He has repeatedly said the central bank’s mandate is to target inflation, not the currency.
Bank watchers said markets would have to adjust to a central bank that is prepared to defy market expectations when it feels action is needed.
“Some central bankers will foreshadow things six months in advance and some will simply respond as the data requires,” said Bank of America-Merrill Lynch economist Emanuella Enenajor. “Stephen Poloz is the latter kind of central bank governor. We’ve gotten very used to being held by the hand and guided by central banks for some time.”
Carney introduced extraordinary forward guidance at the Bank of Canada after the financial crisis, making a conditional pledge in 2009 to keep short-term Canadian rates at a record low for more than a year.
The former Goldman Sachs banker implemented a similar policy when he moved to the Bank of England in 2013, but was criticized by many in the City of London when a faster-than-expected drop in unemployment forced the central bank to alter its original guidelines.
Jeremy Stretch, head of foreign exchange strategy at CIBC World Markets in London, said central banks have almost become prisoners by boxing themselves in with perpetuation of forward guidance: “Mr. Poloz has clearly decided he didn’t want to be boxed in.”
Poloz said on Wednesday he did not like to surprise markets but said Deputy Governor Tim Lane had signaled the negative effect the crash in oil prices would have, in a Jan. 13 speech in Madison, Wisconsin.
But economists and market players zeroed in on Lane’s remarks in a question-and-answer session afterwards, when he said the bank’s analysis of the effects didn’t indicate anything extreme. “We’re not thinking of something that’s drastic,” Lane said.
Accompanying Wednesday’s rate cut, the bank slashed growth forecasts to 1.5 percent from 2.4 percent for the first half of 2015 and cut the inflation outlook for the second quarter to 0.3 percent from the 1.4 percent it predicted in October.
Poloz said he would not characterize the change in the bank’s outlook as “drastic.”
Additional reporting by Leah Schnurr and Mike De Souza in Ottawa, William Schomberg in London, and Alastair Sharp and Solarina Ho in Toronto. Editing by John Pickering.
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