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Interest rate cut for COVID-19 is like surgery with a club: Don Pittis


In the world of finance there are few things people like more than low interest rates.

As anyone who owes money on a mortgage or has borrowed to buy something they couldn’t otherwise afford knows, paying a half percent less in annual interest can make a big difference to your bottom line. Especially when rates are already so low.

The bigger the loan, the bigger the difference it makes.

In the wake of Tuesday’s surprise rate cut by Jerome Powell at the U.S. Federal Reserve, the equally large cut by Stephen Poloz at the Bank of Canada yesterday was not as astonishing as it would have been if Canada had moved first.

As BMO Chief Economist Douglas Porter said yesterday, just after the Bank of Canada cut, the world has changed in a very short time.

“As recently as 10 days ago, any move by the bank today would have been seen as a long shot,” said Porter.

Mired in debt

While generally approving of new monetary stimulus, especially in light of the economic effects of recent rail blockades and the struggling oil and gas sector, the BMO economist noted the dangers to Canadians already mired in debt.

Though it is hard to dispute that making money cheap has the effect of boosting the value of assets, whether houses or stocks, many economists worry that monetary policy may be too blunt an instrument to try to solve an economic problem that requires finesse.

Canadian monetary policy specialist Louis-Philippe Rochon is one of those economists who worries that rate cuts now are not an effective solution to the economic problems created by the global outbreak of COVID-19.

Rochon said he knows he’s part of the economic problem as he considers whether, as a diabetic, he can afford to travel to Rome next month where he is supposed to be visiting professor.

Toronto subway workers disinfect train cars to help reduce passenger worries about spreading the coronavirus. (Michael Wilson/CBC)

 

“It’s a tough decision to make,” he said.

But he has trouble seeing how lower interest rates will fill empty planes, replace parts cut off by factory shutdowns or convince people to go out to restaurants or theatres and feel comfortable taking public transit. Cheap money will not stop people from getting sick.

“I just don’t know how reducing interest rates 50 basis points will help with the coronavirus crisis,” said Rochon who believes the real solution is specific and targeted government spending. “Reducing interest rates will have no impact. No impact!”

Making such a hefty cut in rates may create other problems, he said, including reducing the capacity to reduce rates in the future should the continuing impact of coronavirus lead to the kind of serious financial breakdown warned of by OECD chief economist Laurence Boone.

Up in the air

Just about everything about the coronavirus and its economic impact remains up in the air, from how long the disruption will last, to how profoundly it will affect the global economy.

Certainly, businesses are being hurt. A glance at the headlines in business newspapers and wire services yesterday showed many economic problems were virus-related. The lumber market threatened by falling demand, the virus pushing the aviation industry toward crisis, worries over how many employees could work remotely if the virus worsens, to name  just a few.

But as Rochon points out, an across the board interest rate cut is a handout to everyone who has borrowed money; among U.S. corporations or Canadian consumers, that’s just about everyone.

That’s why, everything else being equal, a cut in interest rates has an immediate positive effect on stock prices and real estate. When the carrying cost of loans declines, assets are worth more.

New data out yesterday from the Toronto Real Estate Board shows home sales are once again on a tear and lower rates could lead to overheating in a hot market. (Michael Wilson/CBC)

Commentators have suggested that Tuesday’s sharp decline in stocks despite the Fed cut showed everything else was not equal. Lower rates, they said, were not enough to save the economy from coronavirus shocks and the sudden move by the Fed only increased financial worries.

The sudden rise in stocks on Wednesday, a day after the Fed cuts, may have more to do with Joe Biden’s wins on Super Tuesday, reassuring shareholders that the previous left-leaning leader of the Democratic pack, Bernie Sanders, was not going to take some of their wealth and give it to the poor.

While strapped Canadians burdened by loans and mortgages may be thrilled by the prospect of lower interest payments, there may be negative consequences. Yesterday, fresh indicators showed the Canadian real estate market may be once again overheating, as the Toronto Real Estate Board reported a sharp increase in sales and prices.

The cut in borrowing costs both here and in the U.S. may be merely storing up problems for an eventual reckoning.

While Poloz is usually reluctant to say he is following the Fed, perhaps one of the best reasons for yesterday’s move is that the impact of a large and sudden asymmetry in rates between Canada and its biggest trading partner would have only added to the economic impact of the coronavirus.

Later today, the Bank of Canada governor will have a chance to explain why he decided a cut in interest rates was essential in a Toronto speech followed by questions.

Follow Don on Twitter @don_pittis



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