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Deeper Canada Rate Cuts Risk Stalling Progress on Debt Purge — Analysis

By Paul Vieira

OTTAWA–The Bank of Canada risks stalling progress by households in purging debt should it become more aggressive in cutting rates, some economists say.

Most economists expect the Bank of Canada to deliver a half-point rate cut Wednesday to revive growth and to ensure inflation stays close to 2% after falling below that threshold in September. The central bank has cut its main policy rate in three straight decisions, and now sits at 4.25%. Five of 13 economists surveyed by The Wall Street Journal last week anticipate another half-point cut in December from Canada’s central bank, given the economy’s underlying softness.

Deeper rate cuts on an accelerated basis risk recharging a Canadian economic model reliant on credit-fueled consumer spending and home buying, according to some analysts. That model lifted growth in Canada for over a decade, leading to one of the world’s heaviest household debt burdens. But it came at the expense of business investment in productivity-enhancing machinery, equipment and software that can lift living standards.

Charles St-Arnaud, chief economist at Alberta Central, a credit-union trade association, is among those expecting an outsized cut this week, in part to guard against further weakness in the labor market. St-Arnaud said the central bank should exhibit caution when the policy rate reaches 3%.

“The Bank of Canada should be concerned of excessively cutting rates and facilitating a return to the unsustainable growth model,” said St-Arnaud, formerly an analyst at the central bank and Nomura Securities.

Beata Caranci, chief economist at Toronto-Dominion Bank, said a half-point cut from the Bank of Canada on Wednesday isn’t required. Part of her argument, like St-Arnaud’s, rests on concern about reigniting a new borrowing binge.

The central bank “must guard against creating a market and household psychology that every hiccup to economic growth expectations necessitates a strong monetary policy response,” she said.

She said Canadian consumers are scaling back consumption and socking away more savings. Statistics Canada data indicate the ratio of debt to after-tax income declined in the second quarter to 174.6% from a mid-2022 high of 184.5%.

She argued that economic growth of 1% to 2% is normal given the degree of debt held by Canadian households. “We need to get comfortable with the uncomfortable,” Caranci said.

Canadian consumers took advantage of the era of sub-2% interest rates following the 2008 global financial crisis. Because Canada’s financial system and housing market emerged relatively unscathed from the crisis, households weren’t forced to shed debt like their U.S. counterparts.

At the time of the 2008 crisis, household debt as a share of Canadian gross domestic product stood at about 80%. The International Monetary Fund’s data indicate household debt in Canada – the bulk of it tied to mortgages – exceeds the size of the total economy, at 102.4% of gross domestic product. That is in line with readings from Australia and South Korea, but well above the U.S., 74%, and the U.K., 83%.

“Deleveraging is crucial to the rebalancing of the Canadian economy,” St-Arnaud said, pointing to a shift, decades in the making, in bank lending. Borrowing by households over decades has crowded out business loans, and St-Arnaud said this helps explain Canada’s dismal productivity performance.

Productivity in Canada fell in the second quarter to a nearly six-year low, and has declined to about 70% of the U.S. level from 88% four decades ago. Bank of Canada officials warn the country needs to improve its productivity, which can help companies earn more revenue and pay higher wages without increasing prices for their goods and wares.

Write to Paul Vieira at paul.vieira@wsj.com

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October 22, 2024 10:36 ET (14:36 GMT)

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