Interest rates set to remain low

Recent weak economic data mean the Bank of Canada will likely keep a lid on borrowing costs.

News on the Canadian economic front has been mostly lukewarm lately. First, national accounts came out that showed the Canadian economy shrank during the past quarter. Then weak housing start numbers were released. As if that wasn’t enough, Canada’s unemployment rate rose to 7.3 per cent in August.

“Looking ahead through the statistical fog, the underlying trend in Canada’s job market is cooling,” notes Douglas Porter, deputy chief economist at BMO Capital Markets. “Don’t read too much into the monthly dip. But plenty of other signs suggest that employment is losing momentum after a surprisingly strong first half of 2011.”

If Porter is right, that has big implications for both politicians and businesses. That’s because job numbers, which often get lumped in with a whole bunch of other economic data (see above), aren’t just some other statistic. They are the key metric that generally governs household formation, buyer demand and thus voter satisfaction. As a result, if job creation is truly on the way down, this will have a big effect on the direction that interest rates take.

The American economy is stalling
Part of the reason that our economy has been so weak is that growth in the United States, our largest trading partner, has been sluggish as well. Job creation down south was near zero during August and when that happens, families stop spending, which, over the longer term, has a direct effect on Canadian exporters.

The other bad news is that the U.S. economy is unlikely to improve quickly. That’s because the two key economic policy actors there have their hands tied. Interest rates have been near zero for some time, which means that the U.S. Federal Reserve has few tools left. The Fed did try to get around this by initiating successive rounds of “quantitative easing” bond purchases in a bid to push long-term interest rates down as well. However, the returns from those moves are diminishing.

On the fiscal front, gridlock in Congress, coupled with massive projected deficits, is making it hard to get any legislation through — let alone new stimulus spending measures, such as president Obama’s proposed US$447 billion American Jobs Act (AJA), an initiative purposely kept small to ensure Congressional approval. As a result, as James Marple, a senior economist at TD Economics notes: “While the [AJA] could materially boost the economy in 2012, it does not address the long-term structural challenges.”

Europe, too, is seeing its share of economic problems. While the old continent has been putting out fires in smaller periphery countries, such as Ireland and Portugal, for some time, things have been looking increasingly grim. For example, as of this writing, speculation has been increasing that Greece may have to organize an “orderly default” on its obligations and may even pull out of the eurozone. As if that wasn’t enough, “bond vigilantes” have also been putting pressure on Italy and Spain — two far larger states — to the point where the European Central Bank was forced to step in to buy their bonds.

Borrowing costs should stay down
The upshot is that Bank of Canada officials are under considerable pressure to keep things as calm as possible, so turmoil elsewhere does not spill over here. As a result, interest rates, which have already been at historic low levels for some time, are likely to remain that way. In its most recent policy rate announcement the Bank of Canada said that it would be keeping its target for the overnight rate at just one per cent.

That’s a far cry from this summer when things were looking more stable here and around the world, leading many to speculate that rate hikes could be on the way. Nobody is talking that way now.

So who are the winners from all of this? Well, people who plan to buy residential real estate, or other large items, and who need to borrow to do so will be getting really good deals. That’s because not only are borrowing costs likely to stay low, but asset prices could come under pressure too.

Peter Diekmeyer is Bankrate.ca’s economics columnist.