OTTAWA - Will the next move by the Bank of Canada be to cut interest rates rather than raise them?
A few weeks ago, the question would have seemed preposterous. Not only were economists such as those on the C.D. Howe Institute monetary policy panel urging bank governor Mark Carney to hike rates and soon, but also the central bank itself was warning Canadians to prepare to pay more for credit.
"To the extent that the expansion continues ... some of the considerable monetary policy stimulus currently in place will be withdrawn," the bank's governing council wrote on July 19, dropping the word "eventually" from the shop-worn advisory.
Get ready for higher interest rates this fall, the markets warned.
But almost nothing has gone as planned since, and Carney himself has backed off the mostly steady as she goes language that had recently characterized his missives on policy direction.
With the U.S. economy stalled, financial markets in turmoil, talk of another recession in the industrialized world growing, economists believe Wednesday's latest announcement on interest rates from the Bank of Canada will be the most gloomy since the recession ended in 2009.
"Almost from the day of the last monetary policy meeting (on July 19) things have gone south," noted Douglas Porter, deputy chief economist with the Bank of Montreal.
"I think there will be a rather sharp turn in language this time. They certainly won't be warning about impending rate hikes."
Most of the shocks have come from abroad, but Canada's economy has also underperformed. The second quarter saw the economy shrink by 0.4 per cent, far worse than the bank's 1.5 per cent call.
The safest bet on Bay Street is that the bank's trend-setting policy interest rate will remain at one per cent Wednesday morning, where it's been for the past year.
Many of the big bank economists believe it will be at one per cent next year at this time as well, a remarkable run of stimulative policy from a central bank that has nightmares about cheap borrowing costs triggering inflation and housing bubbles.
If anything, there's a chance of an opposite move from Carney this fall, says the Goldman Sachs investment house, suggesting the bank could cut its policy rate in half by year's end.
Sheryl King of Merrill Lynch says the market has already begun to price in a rate cut, along with a recession for the U.S.
But right now both are still long odds, she adds.
"The probabilities are elevated, but I still don't think the U.S. economy is falling into a recession," King said.
"We are in a period of slow growth in the U.S., yes," King added. "That makes it more vulnerable to shocks and the possibility of a recession, but if there is a recession it will probably be small, brief and very mild. That would mean the knock-on effects for Canada would be equally mild."
Under that scenario, Carney is likely to keep interest rates where they are, stimulative but clear of the emergency near-zero level he took them to during the slump.
The risk Carney takes on by cutting rates, says Derek Holt of Scotiabank, is that the markets will pressure the bank further toward zero, which has the impact of disrupting money market operations.
"On the other hand, he can't do anything (Wednesday) but talk very dovishly or he risks higher fixed borrowing costs, which he also wants to avoid," Holt adds. "He's in a really tough spot."
Porter says if the worst does occur in the form of a second financial crisis and deep recession, the Bank of Canada would have little choice but to fully reverse course.
That scenario is a possibility, not a probability, he adds. Financial markets are roiling, but the real economy is not in free-fall, he notes. The U.S. consumer continues to spend, although modestly. Even the latest disappointing employment numbers from the U.S. still showed some job growth in the private sector.
In Canada, the outlook remains for muted, but positive growth in the current third quarter.
Most of the negativity comes from sentiment readings, like consumer and business confidence surveys, not from the raw data, says Porter.
"In some ways it feels like we're almost talking ourselves into a recession," he said.
