Bank of Canada Governor Mark Carney held his benchmark interest rate at 1 per cent Tuesday, pointing to global threats on both sides of the Atlantic and weaker-than-expected exports, while also signalling that the domestic economy’s strength is moving him closer to higher rates.
In explaining the decision to leave borrowing costs alone for a seventh consecutive meeting, as expected, the central bank said that “widespread concerns” over sovereign debt problems have “increased risk aversion and volatility in financial markets.” However, Mr. Carney and his rate-setting panel said financial conditions in Canada “remain very stimulative” and the growth of private credit is strong despite global developments.
Moreover, in a teaser to a quarterly forecast they will release Wednesday, policy makers barely touched their growth projections for Canada from 2011 to 2013, and said their preferred gauge of inflation, which is approaching their 2 per cent target sooner than they had predicted, will hover around that level through 2013.
As a result, the central bank dropped a crucial word from the most important paragraph of its statement, indicating that its first rate hike since last September could come sooner than many economists and investors think.
"To the extent that the expansion continues and the current material excess supply in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be withdrawn, consistent with achieving the 2 per cent inflation target,” the central bank said, dropping the word "eventually” that policy makers used in their May 31 decision.
"Such reduction would need to be carefully considered.”
The central bank downgraded its growth forecast for Canada in 2011 ever so slightly, to 2.8 per cent from the 2.9 per cent it predicted in its April forecast, while maintaining that the economy will grow 2.6 per cent next year and 2.1 per cent in 2013.
The economy will pick up in the current half of the year after a second quarter that was marred by the Japanese earthquake’s effects on North American supply chains and as consumers were squeezed by sky-high oil prices, the bank suggested.
Significantly, policy makers also left untouched their April prediction for the so-called output gap – essentially, a measure of the slack left in the economy by the recession – to be closed by mid-2012. Leaving that timeline alone suggests that Mr. Carney won’t be in a hurry to raise interest rates aggressively, since the recovery is proceeding roughly as he expected it would.
At the same time, by not pushing the timeline further out, policy makers signalled that global risks, while worrisome, are not having enough impact on Canada to throw the domestic rebound off course.
In terms of consumer prices, after saying for months that both total inflation and the "core” rate – which strips out volatile items like gasoline and fresh foods, and which the central bank uses as its "operational guide” – would converge around 2 per cent around mid-2012, they conceded that the facts on the ground have shifted their outlook for each measure’s trajectory.
Total inflation, which hit an annual rate of 3.7 per cent in May, will stay above 3 per cent "in the near term,” due to "temporary factors such as significantly higher food and energy prices,” but then return to 2 per cent in mid-2012, the bank said. Annual core inflation, which has been buoyed by strong prices for some services and which hit 1.8 per cent in May, will stay close to 2 per cent.
Although the central bank is not predicting that core inflation will breach its 2-per-cent target, the shift is important because expectations for faster inflation can drive business and consumer behaviour and thus become self-fulfilling.
Still, the central bank also indicated there are many reasons for it to proceed cautiously, suggesting that it is trying to manage expectations for a rate increase at its next decision, scheduled for Sept. 7.
Household demand in Canada is still solid, the bank said, and business investment – a soft spot earlier in the recovery – is ``robust.” However, net exports are still weak, in part because of "ongoing competitive challenges” and the strong loonie but also because of "modest U.S. demand.”
Indeed, the vital U.S. economy, Canada’s No. 1 export market, continues to be held back as consumers tighten their belts and as the labour market fails to produce a meaningful number of new jobs.
Also, growth in much of Europe has outpaced expectations, the bank said, but fiscal austerity in many countries will restrain the continent’s recovery. And the central bank acknowledged that its projection "assumes that authorities are able to contain the ongoing European sovereign debt crisis, although there are clear risks around this outcome.”
The central bank will expand on all of these themes in its full forecast tomorrow, followed by a press conference with Mr. Carney and Senior Deputy Governor Tiff Macklem.
by Jeremy Torobin, The Globe and Mail