Oh Canada: Canada is Drifting Towards Negative Interest Rates

The Bank of Canada has a new governor. 


Tiff Macklem, the former senior deputy governor of the Bank of Canada, was announced on Friday as the new leader of Canada’s Central Bank. The new governor succeeds Stephen Poloz on June 3rd. Throughout his career, Mr. Macklem has been a strong advocate of the Bank of Canada’s 2% inflation target, which puts him a peculiar situation as Canada is currently going through its worst economic crisis, arguably in the countries history. It might be difficult for him to achieve the Bank’s inflation mandate without dipping into “unconventional economic tools,” such as negative interest rates in which he described at a press conference on Friday. 


But first, let’s go through some things Canada is facing economically first: 


Canadian Total Debt in the Economy = 350% of GDP

Even before this crisis, Canada was buried in debt.

When you you add up all the private and public debt, the debt-to-GDP ratio is 350%. Which is unprecedented as it has never been so high.

Today we are seeing major central bank balance sheet expansion alongside endless support from the Federal government to be a backstop for everything which ranges from provinces, companies and households.  

Budget Deficit Projected to be C$252.1 Billion

It is projected Canada’s budget deficit will be C$252.1 billion in 2020 – 2021 due to extreme federal spending and plummeting oil prices.

Just by looking at the year over year deficit figures shows how scary this situation is:

Canadian Budget Deficit History: (CAD dollars)

2007: +$9.6 Billion

2016: -$19 Billion

2017: -$19 Billion

2018: -$14 Billion

2019: -$26.6 Billion

2020:  -$252.1 Billion (Projected)

This represents an astounding 847.7% increase in the deficit over the past year. For economic newbies, the deficit is the difference between the flow of government spending and the flow of government revenues. This 847.7% increase should frighten all Canadians as I truly believe taxation in Canada is going to skyrocket in the coming years to help reduce this unsustainable deficit.

The IMF has issued a projection that shows that Canada’s budget deficit will grow at the fastest pace of any developed country.

This poses major risks to the countries credit rating being dramatically downgraded in the months to come. Economists are quick to point out that net government debt (total government debt minus its cash holdings) was at 40% of economic output before the crisis. On average, developed country debt to economic output was 107%.

However, this should not be misconstrued as something that puts Canada in a position of strength.  When a deficit increases by 847.7% in one month and interest rates spike above economic growth rates, debt ratios will continue to increase dramatically, and economic growth in Canada in the months to come looks extremely bleak, to say the least. 

Canadian GDP: 


Even before the coronavirus, it’s worth mentioning economic growth was already collapsing. Gross domestic product was essentially unchanged in February, showcasing the Canadian economy was drifting towards a recession even before the virus arrived. 

In March, the Canadian economy shrank an estimated 9%. This represents the steepest one-month decline since record-keeping began in 1961. In total, from the January-to-March period, growth contracted around 2.6%.

The Energy Sector Represents 9% of Canada’s GDP

 Last year, the energy sector represented 9% of Canada’s GDP and the key revenue source for several provinces. An important benchmark for the Canadian oil sector is Western Canada Select, and its price has fallen near its lowest levels in history due to a unprecedented storage problem in the oil industry. In fact, oil tankers carrying enough crude to satisfy 20% of the world’s consumption are gathered off California’s coast with nowhere to go as fuel demand collapses:

As the price of oil has plummeted, Canadian energy companies have cut at least C$7.5 billion ($5.4 billion) in capital spending and laid off thousands of workers.

The province of Alberta has estimated the liquidity needs of its energy companies are between C$20 billion and C$30 billion. Banks and oil producers negotiate credit lines twice a year. However, since the value of those reserves have plummeted, Export Development of Canada will become involved.

The EDC will guarantee a portion of the loans that are no longer covered by the reserve value. 

In saying all that, the oil market is far from being out of the woods on a price basis. As Zerohedge pointed out, the analyst who predicted the first wave of negative oil prices sees it hitting minus $100 due to the severe supply imbalance within the industry. This would be detrimental to the Canadian economy as the Federal government continues to provide easy but extremely risky credit to Canadian oil companies. 

Could Negative Interest Rates Arrive in Canada?  

Now the big question, could Canada implement negative interest rates in the months to come? I believe it could.

First, take a look at what the new governor said when asked about the potential of NIRP:

Mr. Macklem response, when asked about negative interest rates: 

“With respect to effective lower bound at 25 basis points, the Bank of Canada has elaborated a framework with unconventional monetary instruments, the possibility of negative interest rates is included on that list…”

He went on to say: 

“It will be hard to explain to depositors why money is taken out of their account…”

However, in the coming months, the Bank of Canada might be able to leverage the fact Canadians have been getting historic support via fiscal policy, which warrants implementing negative interest rates.

For those that don’t know what negative interest rates are, it’s a policy in which borrowers are credited interest rather than paying interest to lenders. It’s hard to comprehend, really. The ECB, Denmark, Bank of Japan, Switzerland currently have negative deposit rates.

As Mr. Macklem touts that the Bank of Canada has unconventional tools, they don’t have much other than negative interest rates and endless QE. Typically in recessions, a central bank has the option of cutting rates dramatically to help stimulate the economy again. 

Like many other central banks, the Bank of Canada will not have that luxury. It’s worth noting, NIRP has proven to be a complete failure in Japan. 

The Bank of Canada in 2018 reported that about 8% of indebted households owe 350% or more of their gross income, representing a bit more than 20% of total household debt. These are the people who would be most affected by an increase in interest rates. 

With near-zero oil prices, a spiraling contracting GDP, a crazy fiscal policy, and Canadian households buried in debt, it is not a question on if negative interest rates come to Canada, but when?