Reluctant borrowers force-fed Dr. Yellen's bitter pill: Don Pittis

In an indulgent age, when everyone wants you to borrow just a little bit more, central bankers are here to offer discipline.

U.S. Federal Reserve chair Janet Yellen proved it yesterday, raising rates by another quarter of a percent.

Her opposite number north of the border, Bank of Canada governor Stephen Polozthis week offered broad hints that he too will begin raising rates sooner rather that later.

And whether Poloz makes his move or not, Canadian borrowers will inevitably begin to feel the pinch asrising U.S. rates increasethe cost of borrowing for Canadian banks. Those are costs that they will, at some point,be forced to pass on to borrowers.

Gutsy stance

Although borrowers won'tlike it, Yellen took a gutsystance in the face of some confusing economicdata.

Essentially, the U.S. chief central banker ignored what is supposed to be the key indicator of whether the Fed should adjust rates. That indicator inflation has not been climbing towards the bank's target rate of twoper cent. In fact, it has been going in the opposite direction.

• U.S. Federal Reserve boosts key interest rate
• Stephen Poloz's comments help send loonie higher

That fact has been used by some business commentators to insist that Yellenhas moved too soon. At yesterday's news conference, financial reporters repeatedly questioned her actions inlight of low inflation.

Yellen had two main reasons for overruling the inflationary evidence.

She blamed most of the drop in inflation to a quirk:an across-the-board decline in U.S. mobile telephone charges in March had a one-time effect on spending costs strong enough to impact the consumer price index. A similar one-time drop in drug prices compounded the effect.

The other is the economy. She predictsthat economic growth and new investment mean that inflation will bounce back after those one-time Marchprice declineswork their way out of the annual statistics.

But she insists thestrongest indicators that inflation is on its way UP is a tightjob market and not just because of a persistent lowunemployment rate of 4.3 percent.

"Whether it's household perceptions orthe availability of jobs, difficulty that firms report in hiring workers, the rate at which workers are quitting their jobs, the rate of job openings all of these indicators do signal a tight labour market," said Yellen.

A tight Canadianlabour market is one of the things that Poloz and his deputyCarolyn Wilkinssay show Canadian rates have to rise.

Not party time

"It isn't time to throw a party, but it does suggest that the interest rate cuts we did two years agohave done their job," said Poloz in an interview with CBC Winnipeg on Tuesday.

Except for thosehoping for a better return on cash savings, Canadians, who notoriously carryheavy debt loads,are unlikely to be throwing any parties over higher interest rates.

"People need to be thinking about what their finances would look like were interest rates to be a little higher when they renew their mortgage," Poloz warned in the CBC interview.

In fact, central bankers who raise rates have a traditional image aspartypoopers, taking away the punch bowljust as things startto get lively.

For overborrowed Canadian consumers constantly being told they can have it all, Yellen and Poloz are like the doctor reminding you to cut down on sausages and sugary drinks before it's too late.

"We want to keep the expansion on a sustainable path," Yellen warned, saying a too-rapid rise in rates risks triggering a recession.

Money is still cheap

As Yellen explained, the latest rise in interest rates, and even the one after that still expected for later this year, will by no means slam the brakes on the economy.

In Fed-speak, interest rates of 1.25 per cent are "still accommodative," that is, below what the true cost of borrowing should be. In other words, for companies looking to make new investments, money is still cheap. For now, at least.

Yellen says those unnaturally low interest rates are just a distortion caused byemergency action by the Fed to rescue the economy in 2008.

Unless something unexpected happens to the economy, Yellen says the gradual process of bringing the economy back to normal is to keep raising interest rates for next several years.

But fixing interest rates isn't the only remnant of the 2008 crashshe faces. The process of quantitative easing, where the U.S. central bank bought up bonds to help flood the economy with cash, has left $4.5trillion USon the Fed's balance sheet.

Yesterday Yellen spelled out a plan to unwind that gargantuan debt pile back onto the market little by little, in a way that will beso boring that it will be like "watching paint dry," she promised.

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