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Loyal BNN viewers might have been confused earlier this week when instead of the normal business chatter, they heard a heated discussion over somebody's ‘tone.’ Some viewers may even have thought they had switched the channel to a daytime talk show by mistake.
But, that ‘tone’ debate pertained to the Bank of Canada and its interest rate decision on Tuesday.
Recently Central bank Governor Mark Carney has used a hawkish tone and signaled he had his finger on a rate-raising pistol. Even while the global economy slowed, Carney has kept his trigger finger poised
And many investors expected this to be the week when Carney & Company shelved the firearms.
But, their expectations were crushed.
Not only did the central bank maintain that its next move on interest rates would be higher, it added a caveat to that warning. After repeated calls for Canadians to pare back their sky-high debt levels, the bank said it might hike rates to dissuade consumers from taking on more debt.
"Over time, some modest withdrawal of monetary policy stimulus will likely be required…the timing and degree of any such withdrawal will be weighed carefully against global and domestic developments, including the evolution of imbalances in the household sector," was how the bank put it.
That's a dramatic change. The bank is now saying it’s willing to walk the talk on its tough stance against high consumer debt levels. While the bank didn't specifically state it will start hiking rates, its ‘tone’ signals that it continues to lean toward tightening monetary policy.
But why are investors so fascinated with the Bank of Canada's tone? Shouldn't it be as simple as knowing whether the bank has or has not raised its benchmark rate?
In monetary economics, tone is everything. At least it is nowadays.
Gone are the times when investors were forced to search for any scrap of information from central bankers, such as Alan Greenspan, the long-time head of the U.S. Federal Reserve, who was reluctant to make the central bank's benchmark interest rate public.
Now central bankers are working hard to be more transparent, offering greater clarity to investors in an increasingly turbulent economic landscape. Under Mark Carney's oversight, the Bank of Canada has been at the forefront of this move.
The most potent example of this change came on April 21, 2009 -- while the financial crisis was still raging and many investors worried the global economy was on the brink of collapse -- when the bank took the unorthodox step of announcing it would hold its benchmark rate at 0.25 percent until the second quarter of the following year. In that moment, the importance of the Bank of Canada's language, and more recently, its ‘tone’, became critical.
At the time, the Bank of Canada and other central banks found themselves in a position where they had hit the so-called ‘lower bound’ of monetary policy – essentially interest rates were already at their lowest level, so they had to find other ways to stimulate the economy. By telling investors how long the rates were going to stay low, they hoped to encourage investment and, ultimately, a jolt to the economy. And the Fed's recent move to increase communication and provide clarity as to when it expects to raise its benchmark interest rate is yet another example of this. The Fed has recently taken to telling investors that it plans on keep interest rate at record low levels until at least through the middle of 2015.
And while the Bank of Canada’s 2009 announcement to keep rates unchanged for a specific amount of time was a foray into uncharted territory, it now finds itself in an equally difficult position. While it can, in theory, lower rates from their current one-percent, the bank has been very public in calling on consumers to use the current low-rate environment to pay off their debt -- not take on more. Consumers have, in large part, ignored those warnings, with Canada’s average household debt-to-income ratios at a record high and nearing the same point reached in the U.S. and other economies prior to the financial crisis.
So, in effect, the Bank of Canada finds itself at another lower bound – it won’t cut rates and allow Canadian households to take on more debt. That leaves it with language and the -- I'll say it again – ‘tone’ of its announcements. By telling Canadians it will hike rates to combat the "evolution of imbalances in the household sector," it’s using language to encourage people to trim their household debt levels without having to use the blunt instrument of higher interest rates.
And while the Bank of Canada says it will one day hike rates, most investors believe that day of reckoning is in the not-so-near future. That means the bank will be stuck playing the language game with Carney & Company for the foreseeable future.Brady Yauch is a writer and web producer at BNN.ca