Bank of Canada overestimated growth; interest rates stay low

Central Bank says Canada will have to earn its success by boosting exports and through investments by the corporate sector.

January 24, 2013
by The Canadian Press

OTTAWA—The Bank of Canada said Wednesday interest rates will need to stay at super-low levels longer—likely until 2014, say analysts—after conceding it misjudged the strength of the economy and reduced its outlook for inflation.

For the 19th consecutive decision date, the central bank’s policy setting team kept the trendsetting interest rate at 1%, where it has been for almost two-and-a-half years.

But the statement and accompanying monetary policy review contained plenty of surprises, the biggest being a new advisory to Canadians and financial markets that the anticipated need to raise rates in the future is now “less imminent.”

It felt free to issue such an advisory, the central bank said, in part because it is less worried about record levels of consumer debt and the housing market, both of which appear to be moderating. And inflation pressures, with evidence the consumer price index will stay around 1% for some time, are at the lowest since the recessionary period.

Prime Minister Stephen Harper said the government has already pencilled in weaker growth for the Canadian economy, adding that the lower level of activity is hurting government revenues.

“There has been a general slowing of the global economy over the past half-year so it is obviously a concern to us. And…it’s going obviously to have some fiscal impact on us, will have some impact on the pace of job creation,” he said.

According to the central bank, Canada’s economy inched along at only one per cent in the last three months of the year—not the 2.5% it had expected.

As well, the bank downgraded growth expectations for 2012 and 2013 by three-tenths on both counts to 1.9% and 2.0% respectively. The bank still has faith the economy will return to strength, however, starting this year and picking up speed in 2014, when growth will average 2.7%.

Given that the economy is now not expected to return to full capacity until the latter half of 2014, the bank says it needs to keep borrowing costs at stimulative levels.

“While some modest withdrawal of monetary policy stimulus will likely be required over time, consistent with achieving the two per cent inflation target, the more muted inflation outlook and the beginnings of a more constructive evolution of imbalances in the household sector suggests that the timing any such withdrawal is less imminent than previously anticipated,” the bank said.

Governor Mark Carney said despite the more dovish tone of his statement, he still believes that next move by the bank, when it comes, will be to raise rates.

“The direction is clear, the timing has shifted,” he said. “But that is still ultimate direction.”

The Canadian dollar ended the trading day down 0.64 of a cent at 100.1 cents U.S. after going as low as 99.96 cents in the morning.

Bank of Montreal economist Doug Porter said he believes the central bank will keep interest rates where they are for the remainder of the year.

“The prior reason for the seeming disconnect between the tough talk and a squishy soft economy was the bank’s laser-like focus on the build-up in household debt,” Porter said. “With the bank now sending some fairly strong signals that it thinks the path for household debt is moderating meaningfully, the case for rate hikes has receded accordingly.”

The interest rate statement and accompanying monetary policy report constitute of a bit of a climb-down for the bank’s forecasting unit, which had been staying with its growth story for the economy as recently as October, when most private sector forecasters were downgrading projections.

The bank’s latest estimates appear more in line with the consensus of private sector economists, although it remains slightly sunnier than the International Monetary Fund, which released a new forecast Wednesday predicting Canada’s economy would advance by 1.8% this year.

The Canadian central bank’s judgment is that the sharp downturn in growth at the second half of 2012 was due to weaker global markets for Canadian exports, uncertainty about how the U.S. would deal with its short-term budget crisis that kept business from investing, and temporary factors, such as shutdowns and pipeline bottlenecks in the energy sector. Along with lower prices, the energy sector difficulties trimmed 0.4 percentage points from Canadian growth in the latter half of the year, the bank said.

The damage will have lasting impacts. Not only is the economy as a whole lower than it might have been at this point, but it won’t return to full capacity until late in 2014.

The economy will need to earn its success, the bank said, by increasing exports to foreign markets and through investments by the corporate sector.

©The Canadian Press