Evidence of meeting #144 for Finance in the 42nd Parliament, 1st Session. (The original version is on Parliament’s site, as are the minutes.) The winning word was economy.
A video is available from Parliament.
Conservative
The Vice-Chair Conservative Pierre Poilievre
Pursuant to Standing Order 108(2), today we are studying the report of the Bank of Canada on monetary policy.
We have with us the Governor of the Bank of Canada, Mr. Poloz, and the senior deputy governor, Madam Wilkins.
Welcome to both of you. The floor is yours.
Stephen S. Poloz Governor, Bank of Canada
Thank you very much.
Good afternoon, Mr. Chairman and committee members. Senior Deputy Governor Wilkins and I are pleased to be with you today to discuss the bank's monetary policy report, which we published just last week.
At the time of our last appearance in October, we saw signs that the Canadian economy was moderating after an exceptionally strong first half of the year. Now that moderation turned out to be greater and to last a bit longer than we expected at the time. Still, it's important to recognize that inflation is on target and that the economy is operating close to potential.
Now that statement alone underscores the considerable progress seen in the economy over the past year. The slower than expected growth in the first quarter just passed reflected two main issues.
First, housing markets reacted to announcements of new mortgage guidelines and other policy measures by pulling forward some transactions into the fourth quarter of last year. That led to a slowdown in the first quarter that should naturally reverse.
Second, we saw weaker than expected exports during the first quarter. This weakness was caused in large part by various transportation bottlenecks. Some of this export weakness should also reverse as the year goes on. So, after a lacklustre start to 2018, we project a strong rebound in the second quarter. All told, we expect that the economy will grow by 2% this year, and at a rate slightly above its potential growth rate over the next three years, supported by both monetary and fiscal policies.
The composition of growth should shift over the period, with a decline in the contribution from household spending and a larger contribution from business investments and exports.
Inflation should remain somewhat above the 2% target this year, boosted by temporary factors. These factors include higher gasoline prices and increases to the minimum wage in some provinces. Their impact should naturally unwind over time, returning inflation to 2% in 2019.
Of course, this outlook is subject to several important risks, and a number of key uncertainties continue to cloud the future, as was the case in October.
The four main uncertainties around the outlook for inflation are the same as we mentioned six months ago, but good progress has been made on some of them.
First, in terms of economic potential, our annual review led us to conclude that the economy currently has more capacity than we previously thought. As well, this capacity is growing at a faster pace than we expected. This means that we have a little more room for economic demand to grow before inflationary pressures start to build. That said, some firms, particularly exporters, are operating at their capacity limits, but are hesitating to invest. This hesitation may be due to trade uncertainty, the transportation bottlenecks, shortages of skilled workers, or other reasons. Regardless, it is limiting growth of our exports and economic capacity.
The second source of uncertainty concerns the dynamics of inflation. Here, recent data have been reassuring. Inflation measures, including our various core measures, have been behaving very much as forecast, and they are consistent with an economy that is operating with very little slack. This gives us increased confidence that our inflation models are working well.
The third area of uncertainty concerns wages, and the data here are also all encouraging. Wage growth has picked up significantly over the past 18 months. It is now approaching the 3% growth rate that one would expect from an economy that's running at capacity. However, the most recent figures are being boosted temporarily by the minimum wage increases in some provinces.
The fourth source of uncertainty is the increased sensitivity of the economy to higher interest rates, given elevated levels of household debt. The concern is that as interest rates rise, the share of household income going to service debt will also rise. This will leave less to spend on other goods and services and put downward pressure on inflation. It will take more time for us to assess this issue, particularly because new mortgage guidelines are currently affecting the housing market and mortgage lending. However, the growth of household borrowing is slowing, which is consistent with the idea that consumers are starting to adjust to higher interest rates and new mortgage rules.
As you can see, there has been some progress on these four key areas of uncertainty in the economy, particularly the dynamics of inflation and wage growth. This progress reinforces our view that higher interest rates will be warranted over time, although some degree of monetary policy accommodation will likely still be needed to keep inflation on target. The bank will continue to monitor the economy's sensitivity to interest rate movements and the evolution of economic capacity. In this context, the governing council will remain cautious with respect to future policy adjustments, guided by incoming data.
With that, Mr. Chairman, Senior Deputy Governor Wilkins and I would be happy to answer your questions.
Conservative
Liberal
Greg Fergus Liberal Hull—Aylmer, QC
Thank you, Mr. Chair. It's nice to have you chairing the committee.
Mr. Poloz and Ms. Wilkins, thank you both for your presentation. My question has to do with housing, which is very important to the people in my riding and, of course, the Canadian economy as a whole.
You said you were in the midst of assessing Canada's housing market, particularly as regards mortgage rates. Could you elaborate on how higher interest rates could affect Canada's housing market in the short and medium terms?
Governor, Bank of Canada
As I mentioned earlier, it's definitely an issue that's very important to us.
I will let my colleague answer your question.
Carolyn A. Wilkins Senior Deputy Governor, Bank of Canada
Thank you for the question.
A number of factors are currently impacting the housing market, namely monetary policies and higher interest rates, as you mentioned.
Obviously, interest rate increases go hand in hand with mortgage rate increases. As people start to feel the effects of the increases, their capacity to purchase a first home or enter the housing market will become limited. The increases will also influence the decisions of those looking to purchase a larger home.
This is something we can capture in our modelling. The housing market can clearly support higher interest rates. The new mortgage lending guidelines seem to be having an effect as well. They basically serve as a stress test for borrowers. It's important to make sure borrowers are able to handle higher interest rates.
The data show that, prior to the guidelines coming into effect on January 1 of this year, people decided to purchase a home during the fourth quarter of last year to avoid being subject to the guidelines. That led to a slowdown in the first quarter of this year, as resale housing data show. Right now, we're trying to figure out just how temporary that effect is. The data show that resales peaked in March. According to our projections, the housing market should start to pick up in the second quarter. As far as household debt is concerned, our hope is that a more favourable composition will emerge as the economy begins to reflect the impact of these guidelines.
Liberal
Greg Fergus Liberal Hull—Aylmer, QC
My next question is on that very topic.
Do you have any indication that the guidelines meant to cool the housing market have had the desired effect? Have we avoided the crisis we were anticipating, or fearing, a year or a year and a half ago?
Senior Deputy Governor, Bank of Canada
The main purpose of those measures was not to cool the housing market but, rather, to improve the composition in terms of household debt. A year ago, we introduced a series of measures applicable to mortgages insured by the government. We have seen a significant drop in the percentage of highly indebted individuals. Those measures have had the desired effect. We've also seen speculation in the housing market seemingly decline.
In our view, both of those effects are desirable. That said, it's too early to say what impact the measures that came into effect on January 1 will have. We'll have a better idea this summer and in September, once the data come out.
Liberal
Greg Fergus Liberal Hull—Aylmer, QC
I'd like to thank Ms. Wilkins for correcting me. The measures were not, in fact, intended to cool the housing market, but, rather, to change the composition. The goal was to foster a more resilient mortgage environment, in response to externally motivated economic changes, to ensure people could cope with problems tied to changes in the economy. That brings me to what may be my last question, depending on the answer.
You talked about keeping the interest rate at 2%.
How would a rate increase affect Canada's economic growth?
Would that impact be spread evenly across the country, or would it be felt more in certain regions?
Governor, Bank of Canada
That comes back to the most important issue, which I mentioned earlier. We are certain that the economy is more sensitive than before to interest rate fluctuations, and that is due to the level of household debt. In the fall, we re-evaluated our model and found the economy to be about 50% more sensitive than before to interest rate fluctuations. It's important that the impact be symmetrical, meaning, that the economy needs to be just as sensitive to interest rate reductions, since changes in monetary flows will work both ways.
That said, it's an issue we examine. Every month, in Newfoundland and Labrador, we check the data to determine whether the state of affairs is more or less in line with our modelling projections. As Ms. Wilkins mentioned, the situation is a bit complicated because we've made other changes at the same time. We'll probably have to wait a few months before we are able to define the key changes. Basically, the economy is just as sensitive, if not more, than it was before, and that could yield the same effect as in the past. The impact, however, could also be more significant. That is the current situation.
Conservative
Tom Kmiec Conservative Calgary Shepard, AB
Thank you, Mr. Chair.
On page 19 of the monetary policy report you say that “limited pipeline and rail capacity out of Western Canada could discourage longer-term investment in the oil sands”.
Can you give me an idea of how much pipeline rail capacity problems are hurting the Canadian economy? Could you include some GDP numbers and some job numbers too?
Governor, Bank of Canada
That sounds like a fairly straightforward question, but it's not. Our focus there, as you mention, is that the lower net price received by Canadian producers of new oil from the oil sands in particular, heavy oil, is a factor that is constraining investment in new projects in that particular sector. For us, for forward-looking purposes, that's the most important channel of effect.
The question about the gap between WCS and WTI and the effect it's having on the economy has a lot of complicated calculations in it. Not all of Canadian oil production, of course, is paid that price. Some of it is already committed on a pipeline. Other companies have a full upstream and downstream system so aren't hit by the same issue. As well, part of the premium is paid to the transportation companies, so some of that money stays in Canada.
It's very hard to isolate that number. It's not that important to us in the sense of how to make a forecast. It's important that GDP is what it is. The question is, how will it grow from here? In that case, we believe that investment in that sector will remain flat in our forecast because, of course, one of our assumptions is that oil prices stay constant in our forecast.
Conservative
Tom Kmiec Conservative Calgary Shepard, AB
Okay. Just for a change of pace, I'm going to refer to a report by the Bank of Canada, the financial system review from December 2016, because I have a question about mortgages. You've mentioned this several times here.
Under the heading “New policy measures will change the behaviour of lenders and borrowers”, there's a section on page 8 that says, “All else being equal, 43 per cent of their high-ratio mortgages and at least 59 per cent of their portfolio-insured mortgages issued over the 12 months ending in September 2016 would not have qualified for mortgage insurance under the new rules.”
Those are the rules that at the time were changed in September 2016, and by December 2016 the Bank of Canada was able to provide information on what the impact would be in terms of a comparison and who would qualify and who wouldn't. Do you have the assessment done for the changes to the B-20 rules?
Senior Deputy Governor, Bank of Canada
Yes. Just to put that assessment in context, the assessment is really done so that we can figure out how much it's going to affect GDP. Okay? We need to know that to forecast inflation, so the assessment is really an estimate, a rough estimate.
The way we calculate that is to look at the prior year. In that case, it would have been the year before. For this particular change, it's the prior year as well. We calculate, if the profile of the people who applied for mortgages was exactly the same, how many wouldn't have met it. What we find in the work we published in our November 2017 FSR is that about 10% of uninsured borrowers would have failed the test. Many of those would have been in Toronto and Vancouver. It's not surprising, because that's where house prices are the highest on average.
That doesn't mean that all those borrowers would no longer buy a house. What they could do is decide to wait a bit and then buy a house once they've saved more, or they could decide instead to buy a less expensive house; that's what we need to wait and see for these current changes. What we noticed from the changes from a year ago that were acting on the insured space was that about half of the people who didn't qualify decided to just wait a really long time and not buy a house for a while. The other half decided to adjust and purchase a less expensive house.
Conservative
Tom Kmiec Conservative Calgary Shepard, AB
How long does it take the Bank of Canada to do that type of assessment? How many months of data do you need before you can provide a good assessment on the impacts of the B-20 mortgage rule changes?
Senior Deputy Governor, Bank of Canada
I think it's going to take about a year.
Senior Deputy Governor, Bank of Canada
We'll have a better idea by September, as I said in response to the previous question, to get a really full assessment. Even then, you have an identification problem because there are more things changing at the same time—for example, our past interest rate increases. We should have a better idea in a few months.
Conservative
Tom Kmiec Conservative Calgary Shepard, AB
In 12 months?
In your statement, Governor, you said that there's this slowdown down in the first quarter that should “naturally reverse”. What did you mean by “naturally reverse”? Also, in your opinion, when will the real estate market reach the new volume equilibrium?
Governor, Bank of Canada
We have three things happening to the housing market at the same time. One is that interest rates have risen since last year, and so we're watching for that effect. That would have a longer-term effect on the market. Second is that we have the change to B-20, which would also have a longer-term effect on the market. The third thing is the pull-forward part, which brought sales from the first quarter into the fourth quarter, and that part we would expect to regularize. We have low sales in the first quarter because of the high sales in the fourth, but by the time we get into the second quarter or certainly into the third, we should see things reaching a more stable place. That stable place will include all three of the effects I mentioned, not just the one. The big fluctuation we've seen will naturally reverse itself just because fundamentals remain very strong.
Conservative
Tom Kmiec Conservative Calgary Shepard, AB
Mr. Governor, what baseline do you expect to see in the third quarter?