Stephen Poloz says rate guidance is 'addictive' for markets

Bank of Canada governor Stephen Poloz says guidance on the future direction of interest rates should be reserved primarily for when rates are at their lowest possible point.

• Bank of Canada holds key interest rate at 1%

In a discussion paper released Friday, Poloz said forward guidance reduces uncertainty about the future direction of rates and, when rates can go no lower, it can reassure markets.

However, he noted such guidance is not without cost and there may be significant volatility when markets perceive the central bank is preparing to change its position.

In short, forward guidance can become addictive for markets if it is overly precise or heavily weighted with caveats- Stephen Poloz, Bank of Canada governor

"The idea is that this will enhance the economy's response to low interest rates," Poloz wrote.

"The Bank of Canada temporarily exercised this form of guidance in the wake of the financial crisis, and to good effect."

During the financial crisis, the Bank of Canada slashed rates to 0.25 per cent in April 2009 and then-governor Mark Carney said rates would remain there until the second quarter of 2010, conditional on the central bank's outlook for inflation.

Poloz also said that forward guidance is inevitably conditional on assumptions and forecasts.

Fragile equilibrium

"While this is appropriate, what it does is to create a fragile market equilibrium in which every new data point can be interpreted as a potential caveat, and markets may need repeated doses of reassurance," he said.

"In short, forward guidance can become addictive for markets if it is overly precise or heavily weighted with caveats."

Poloz said dropping the forward guidance shifts some of the policy uncertainty from the central bank to the market - something he said is "a more desirable situation in normal times."

The central bank's key rate has been set at one per cent for more than four years.

The Bank of Canada has a neutral stance on interest rates, suggesting there is an equal chance it will raise or lower rates.

Its next rate announcement is set for Oct. 22 when it will also release its latest monetary policy report.

Economists widely expect the rate to remain unchanged.