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Forex News

Financial vulnerabilities can make it harder to hit inflation target – Reuters

As reported by Reuters News, “Financial vulnerabilities like high household debt could undermine central bank efforts to keep inflation in check, since they potentially limit the effectiveness of rate cuts, a top Bank of Canada official said on Thursday.”

The Deputy Governor, Paul Beaudry, was speaking today in a lecture to university students in Quebec City but made no mention of future rate moves and said an environment where inflation was low, stable and predictable remained ideal.

Achieving this, however, cculd become more challenging given increased risks posed by vulnerabilities linked to balance sheets, asset prices and risk allocation, he noted.

“The same policy choice that helps the central bank achieve its inflation target in the short run may be making it more difficult to attain its target in the longer run,” Beaudry said.

Canada’s central bank, which has sat on the sidelines for more than a year even as several of its counterparts have eased, held its overnight interest rate steady as expected Jan. 22 but left the door open a possible cut if a recent slowdown in domestic growth persists.

Key notes

  • Beaudry says financial vulnerabilities can make it harder for bank to meet inflation target.
  • Financial vulnerabilities can cause rate changes to have different effect in short term than in long term.
  • Does not touch upon possible economic impact of coronavirus in speech.
  • Three main financial vulnerabilities are tied to balance sheets, asset prices and risk allocation.
  • Financial vulnerabilities evolve more slowly than traditional monetary factors, and impacts are harder to predict.
  • If we bring financial vulnerabilities into equation, it means introducing degree of flexibility into inflation-targeting process.
  • It is not yet entirely clear how important these channels are, but there is sufficient evidence to warrant our attention; relevance of financial vulnerabilities for monetary policy remains a debated issue.
  • Last October, bank could have considered rate cut to ensure economy didn’t perform below potential.
  • But given state of financial vulnerabilities last Oct, we judged risk of reigniting acceleration in house price expectations and debt buildup was too high.
  • Even if a rate cut looks desirable in short-term, once bank has factored in growth at risk, the cut may no longer look attractive.
  • This is not a departure from our inflation-targeting objective but rather another tool to judge risks to inflation outlook.
  • Even if the macroprudential policy is best suited to ensure resilience of financial system, that doesn’t mean it is capable of eliminating all risks associated with financial vulnerability
  • Financial vulnerabilities can make it harder to hit inflation target.

USD/CAD implications

The pair has fallen on the comments, correcting the highs of the day. There will now be a focus on the Gross Domestic Produce data on Friday. 

Previewing the data, “TD looks for a flat print on industry-level GDP for November, in line with the market consensus, for the third consecutive month of <0.1% growth,” said TD Securities analysts. “With softer manufacturing shipments and energy production, we look for a muted increase in services to provide the main engine of growth. “

More to come…

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