In this interview with BNN, Ed Devlin talked about the Bank of Canada’s approach to interest rates, inflation, and potential upcoming changes in the Canadian economy.

Ed Devlin began by saying that the Bank of Canada not raising interest rates is what was expected, with the bond market pricing in a 40% chance of a rate rise in the coming year. In his view, the bond market was very volatile at the moment, having been whipsawed with big rate swings up and down, partly due to the Bank of Canada’s unexpected rate increases.  Because wages were not increasing much, Ed stated that he believed inflation will not accelerate and that the Bank can be cautious and must watch how sources of uncertainty – such as the US-China trade war – play out. In his opinion, most of the recent drop in inflation was due to temporary effects, so core inflation is pretty close to 2%, which should be acceptable for the Bank. He thought the housing market has “come off the boil” for the time being, but that it wasn’t obvious how it will play out over time since it is hard to tell how sensitive the housing market is to the various changes in interest rates and mortgage lending rules. While there are concerns that a negative yield curve in the US is a predictor of a recessions, that is less true for Canada where, in any event, it is poised to become steeper.

Ed was not convinced that any transition from consumer debt-driven growth to business investment and export expansion driven growth will be a smooth one. He thought that Canadian export growth has been disappointing, as conditions abroad would have suggested that we should be doing better. He was also skeptical about the Bank of Canada’s economic growth forecast, which reflects their optimism about exports. While the Canadian dollar has strengthened, Ed stated that this was expected due to market conditions, with the gains reflective of a sell-off of the US dollar. He said that it is not clear if the US will continue to be the driving force in the global economy, with China taking the lead.

While stock market prices are a useful indicator for central banks to watch, they are only one component of the financial conditions index that are monitored for their effects on the macro-economy. A key concern for central banks is to avoid going into a recession with low interest rates that restrict their ability to use countercyclical monetary policy. A key difficulty is identifying the neutral rate of interest, which the Federal Reserve and Bank of Canada estimate to be between 2.5 and 3.5%. With no evidence of higher wage growth and an overheating economy, however, some analysts think the neutral rate may be as low as 2%. The neutral interest rate may already have been reached in Canada, though the low wage growth could also be related to labour market trends such as the gig economy, higher participation rates, and favourable immigration policies (at least in Canada).