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Lower Inflation Means Low Interest Rates, Says Economists

23 October 2012

Mark Carney is expected to make his next scheduled interest rate announcement today to let us know whether rates will be going up or down over the next couple of months. It’s thought that, as it’s been for the past two years, the overnight lending rate is going to be kept at 1 per cent. Especially, says one economist, when you consider that inflation is also currently low.

According to a Statistics Canada report last week, the inflation rate for the month of September stayed at its 1.2 per cent. That’s the lowest it’s been in two years, and it’s not the first time this year we’ve been there either. August and May also enjoyed that same inflation rate. In addition to that, core inflation was lowered to 1.3 per cent – three-tenths of a point lower than what the Bank of Canada had predicted for that quarter. David Madani, an analyst with Capital Economics, says that it’s because of this that there will likely be no change to the interest rate for the time being.

A look at the chart below will tell you just where our inflation lies when compared with last year. While in the last year we may have all felt the crunch at the gas pumps, and at retail stores when buying the latest fashions, a number of prices on other commodities went down – including women’s clothing. Along with that, mortgage interest, natural gas, and video equipment also went down.

“The fact is that not just core inflation, but any measure of underlying inflation remains very subdued,” says Mr. Madani. “In this environment obviously the Bank of Canada isn’t really in a hurry to raise interest rates and there’s obviously good reason for that – the slowdown in the global economy, and now signs that the domestic housing market is correcting.”

And he may not be wrong. Earlier this week Mark Carney gave a speech in British Columbia, in which he stated that tightening policy probably wasn’t needed at this time. It’s thought that this is the same kind of language we’ll hear upon his announcement today.

But while many of us might be expecting to hear that the interest rate is remaining where it’s been at for the last two years, others think such an announcement would show signs of indecision on Mark Carney’s part.

“Such a move would mark the second time in two years that the central bank has had an about face,” says Mark Chandler of RBC Dominion Securities, when talking about the chance that Carney probably will keep the rate where it’s at.

Mr. Chandler is referring to the fact that Mark Carney has been calling for a tightening of the policy, which would mean a rise in rates. But such talk was simply to stem household borrowing, and keep people from getting into much more debt than they could afford to service. And at a time when our debt levels are higher than they’ve ever been before. Now that the new mortgage rules are in place – and especially given that inflation is at a low – there really doesn’t seem to be any need for raising the rate.

It’s far more likely than instead of being wishy-washy, Mr. Carney is simply moving with the market and making adjustments where needed. Now that the housing market is starting to cool, and it’s become much harder to get a Canadian mortgage, he most likely doesn’t see the need to raise rates and strap us for cash even more so.

And that’s likely why today, the interest rate will remain just where it is.

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