The Bank of Canada (BoC) today reduced its target for the overnight rate to 4½%, with the Bank Rate at 4¾% and the deposit rate at 4½%. The BoC is continuing its policy of balance sheet normalization – selling off debt previously purchased to stimulate growth. The Prime interest rate at major financial institutions will adjust to 6.7%
The tightrope that the BoC is walking has to do with the long-standing productivity problem that is quickly reaching “emergency levels,” says BoC governor Tiff Macklem, “Our Achilles heel is productivity.” Further, he has stated: “We have been very good at growing our economy by adding workers. We have been much less successful at increasing output per worker, and this is catching up with us.”
Former Bank of Canada governor Mark Carney has also warned (in April) that Canada’s prosperity would be harmed unless Ottawa manages to raise productivity, saying the government has “less to spend because we have become less productive…And unless we turn that around, Canadian prosperity for all Canadians will be severely compromised because we can’t redistribute what we don’t have.”
If productivity remains low and wages continue to increase it will cause higher inflation, all else being equal. The problem is that Canada’s GDP growth is lower than competing Western economies. The solution is to increase business investment in the Canadian economy to improve productivity. Canadian businesses invest significantly less per worker than U.S. businesses.
Taxation levels in Canada, including the Carbon tax, discourage businesses from investing. High taxation has chased many good companies out of Canada, seeking to find lower tax regimes in other countries, primarily the U.S.
In summary, the Bank of Canada would like to lower its Key Rate to encourage economic growth but by doing this, because of productivity issues, this could spur inflation upwards. This is the tightrope.
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