Gloom over debts and NAFTA threats trounced by 'positive surprises': Don Pittis

It will likely be a hard sell for Canadians pinched by another increase in debt payments, but the Bank of Canada says yesterday's interest rate hike was a cheerfulsign for the economy.

Inevitably, thequarter point increasehad an immediate andsignificant impact on Canadians with variable rate loans and lines of credit.

Bank of Canada governor Stephen Poloz and his senior deputy, Carolyn Wilkins, didn't deny that impact in their news conference yesterday. It forms the basis of one of their biggest worries.

Danger of debt and NAFTA

The danger of shocks to an economy dependent on debt and the threatimplied by the potential collapse of the North American Free Trade Agreement can't be ignored, they said.

But the reason for a rate hike should not be ignored either. And thatis a flood of good news expected to continue to benefitCanadians as the economy strengthens.

"There's noquestion that the data on balance since October has been stronger than our base case,"Poloztold a gathering of financial reportersyesterday. "Given that the string of positive surprises has encouraged us in the underlying narrative, we're feeling more confident in the outlook."

That said, of course, it was interesting to hear how the Bank of Canada's two senior peopleresponded to a reporter's question about what keeps them awake at night.

The stuff of nightmares

Polozwent first andconfessed that trade and the potential loss of NAFTAwas one of the things that made him lose sleep. And indeed the bank's monetary policy report warns that the reversal of decades ofmore open trade would hurt Canada.

"The prospect of a notable shift toward protectionist global trade policies remains the most important risk surrounding the outlook," the report says.

But in his discussion of the trade issue, PolozinsistedNAFTAisn't an on-off switch for the Canadian economy. The deal alone isn't the difference between doom and a secure economic future.

And although he didn't mention President Donald Trump by name,Poloz observed that U.S. actions were hard to predictand that "we cannot presume it will be a small shock."

While he said most economistsagree Canadians and Americanswould be better off with free trade, the exact implications to individual industriesare impossible to know in advance, justas we discovered when everyone was making predictions about the effects of the first Canada-U.S. free trade deal in the late 1980s.

"The Canadian wine business was going to be wiped out by the trade agreement," Polozsaid. "Well, look what we have today!"

The more immediateimpact of the uncertainty over NAFTA, Polozsaid, is that Canadian businesses continue to delay some of their investment decisions until they see what happens. They are investing plenty, but the bank's surveys show they would invest more if they knew NAFTAwas secure.

After outlining his worst nightmare, Polozturned the question over to his senior deputy.

Household debt, obviously

"There's one thing you didn't mention, maybe because it is so obvious," Wilkinssaid. "And that's really household debt that'skeeping me up at night."

For heavily indebted Canadians,yesterday's increase, coming so soon after two similar quarter point hikes last summer, will make a hole in their budgets. Expectations of two more hikes this year meansinterest payments will be sharply higher than they were just a year ago.

That tells us a bigger share of household budgetswill move to loan repayments. At the same time, higher rates will likely reduce the number of people borrowing against their houses. Both those things could impactthe growth ofconsumer spending.

But interestingly that is not the stuff of Wilkins's nightmares. The scary thing, she says, is if external factors similar to the oil price crash that happened earlier this decade were to suddenly hit the Canadian economy. Being so heavily indebted would compound the impact on Canadians.

"It's just the vulnerability we would face if we had a shock," she said.

The reason Wilkins is worried about an economic shock and not about the effects of agradual increase ininterest rates is that the overall economy is healthy and growing.

Despite a pullback by the most indebted, consumer confidence is growing. Unemployment is falling as the economy creates more goodjobs than expected. Wages are rising slightly faster than inflation. Productivity the value of goods and services created with every unit of labour while not stellar, is going up.

Rates still historically low

There are plenty of other positive signs. Europe and other Canadian trade partners areshowing strength.

Despite squabbling over trade, the economy of the U.S., Canada's biggest trade partner of all, continues to surge. It, too, is putting more of its people to work, expanding capacity as it draws discouraged workers back into the active labour force.

• Big banks move to match Bank of Canada's rate hike
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In Canada, says Poloz, there are signs the same thing is beginning to happenas businesses invest in new commercial buildings andequipment.

And despite the risein rates, Canadian interest is still what the bank calls "accommodative," meaning rates are still stimulating the economy as it uses up excess capacity, andborrowing is still a bargain compared to how much money you can earn with the money you borrow.

"Everybody's better off with a strong economy," Polozsaid. "A stronger economy means interest rates can move a little closer to something more normal, in a context where everybody's better off."

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