Bank of Canada Quarterly Monetary Policy Report

October 26, 2011

The October Report contains more detailed information than was included in Tuesday’s statement following a decision to leave the Bank of Canada’s overnight target rate unchanged at 1.0%, its level since early September 2010.  Here are the most interesting revelations.

Total and core CPI inflation, which in 3Q11 were 3.0% and 1.9% greater than a year earlier, are projected to bottom out respectively at 1.0% in 2Q13 and 1.6% in the final quarter of next year.  The July Monetary Policy Report had projected headline CPI at 1.9% in 2Q13 and core CPI at 2.0% in 4Q13.  Headline and core CPI do not rise back to 1.9% in the new forecast until 2Q13 and only reach the targeted 2.0% level again in 4Q13, eight quarters from now.  That leaves plenty of time before anymore rate increases become necessary.

On-year Canadian GDP growth in the first quarter of 2012, which had been projected at 2.9% in the April 2011 Report and at 2.5% in the July Report, was revised down very sharply to 1.1%.  Some of this change reflects a 0.4% GDP drop in 2Q11 instead of the 1.5% increase assumed three months ago.  In addition, officials project growth of just 0.8% in the present quarter, revised from 2.0% assumed three months ago.

A combination of weaker actual growth and accelerating potential growth — projected at 1.6% this year followed by 2.0% in 2012, 2.1% in 2013 and 2.2% in 2014 — will push back the restoration of full productive capacity usage to the end of 2013 from mid-2012 assumed three months ago.  This date plays critical importance in guiding Canadian monetary policy.  At less than full capacity, actual growth can exceed potential growth without lifting inflation higher.  Central bank officials believe the discrepancy between the actual and potential levels of GDP last quarter was approximately 1.25% in size, and such will widen near term before shrinking anew.

The central bank’s forecast for global economic growth in 2012 has been revised down to 3.1% from 4.0% assumed in July.  Bank officials believe Euroland GDP will slip into recession in the current quarter and post average growth in 2012 of only 0.2% even if the euro-crisis is contained, which it might not.  An uncontained European crisis and a higher probability of a U.S. recession in 2012 are explicitly cited as the two main downside growth and inflation risks for Canada.  In the central bank’s baseline forecast, U.S. real GDP in the first half of 2012 is penciled in at 1.25% annualized.

The main drag on Canada’s economy continues to be net exports.  A “significantly less favorable external environment affects Canada through financial, confidence, and trade channels.”  Net exports are now expected to exert a 0.9 percentage point drag on Canadian 2011 GDP growth, which is half a percentage point (ppt) greater than assumed just three months ago.  The positive growth contributions from external demand is likely to be only 0.2 of a ppt next year and 0.1 ppt in 2013. 

Projected growth contributions in 2012 from personal consumption and business investment were revised downward by 0.4 ppts apiece to 1.6 ppts and 0.7 ppts compared to what officials were assuming in the July Report.  The drag from government spending will be some 0.2 ppts less than imagined before.

This is a dovish document. Officials still maintain that price risks surrounding the baseline forecasts are balanced.  One upside price concern not stressed is that an assumption that WTI crude oil ranges narrowly at $87-88 per barrel over the next eight quarters may prove too conservative.  Be that as it may, this report serves notice implicitly but not explicitly that it may be necessary to cut the 1.0% overnight interest rate target at the sign of further intensifying trouble in the global economy.

Copyright 2011, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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