OTTAWA – Bank of Canada governor Stephen Poloz is recommending pension funds get ready for a new normal: neutral interest rates lower than they were before the financial crisis.
Poloz told a Wall Street audience Tuesday that the fate of neutral rates – the levels he said will prevail once the world economy recovers – remain unknown, but they will almost certainly be lower than previously thought.
The central banker made the comment during a question-and-answer period that followed his speech on global trade growth.
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Among the reasons, Poloz pointed to the more-pessimistic outlook for potential long-term global growth. The forecast was lowered to 3.2 per cent from four per cent, he said.
“That downgrade means the neutral rate of interest will be lower for sure – for a very long time,” said Poloz, who added it could go even lower if economic “headwinds” continue.
“Those in the pension business need to get used to it. They need to adapt to it.”
Since the 2008 global financial crisis, pension funds around the world have had to contend with market uncertainty, feeble growth and record-low interest rates.
Pension funds use long-term interest rates to calculate their liabilities. The lower the rates, the more money plans need to have to ensure they will be able to pay future benefits.
A December report by the Organization for Economic Co-operation and Development said the conditions have “cast doubts on the ability of defined-contribution systems and annuity schemes to deliver adequate pensions.”
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To cushion the Canadian economy from the shock of lower commodity prices, Poloz lowered the central bank’s key rate twice last year to 0.5 per cent – just above its historic low of 0.25.
Poloz linked the higher neutral interest rates of the past to the baby boom, which he described as a 50-year period of higher labour-force participation and better growth.
“Well, that’s behind us,” Poloz told the meeting of the Investment Industry Association of Canada and the Securities Industry and Financial Markets Association.
“We don’t have numbers for all this, but you need to be scenario-testing those pension plans and the needs of your clients because the returns simply won’t be there.”
But with all the unpredictability Poloz said it remains possible current headwinds could convert into positive forces that would push interest rates back to “more-normal levels” seen prior to the crisis.
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Earlier Tuesday, Poloz’s speech touched on another aspect of the post-crisis world.
He told the crowd they shouldn’t expect to see a return of the “rapid pace of trade growth” the world saw for the two decades before the crisis.
Poloz was optimistic, however, that the “striking weakness” in international trade wasn’t a sign of a looming global recession.
He said the renewed slowdown in global exports is more likely a result of the fact that big opportunities to boost global trade have already been largely exploited.
As an example, he noted China could only join the World Trade Organization once.
Poloz expressed confidence that most of the trade slump will be reversed as the global economy recovers – even if it’s a slow process.
“The weakness in trade we’ve seen is not a warning of an impending recession,” said Poloz, a former president and CEO of Export Development Canada.
“Rather, I see it as a sign that trade has reached a new balance point in the global economy – and one that we have the ability to nudge forward.”
He said there’s still room to boost global trade through efficiency improvements to international supply chains, the signing of major treaties such as the Trans-Pacific Partnership and the creation of brand new companies.
Poloz’s speech came a day after Export Development Canada downgraded its outlook for the growth of exports.
EDC chief economist Peter Hall predicted overall Canadian exports of goods and services to expand two per cent in 2016, down from a projection last fall of seven per cent.
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