Bank of Canada Monetary Policy Report Update

July 18, 2012

New forecasts by the Bank of Canada embodied in its Policy Report Update released today show a weaker profile for 2012 than envisaged three months ago.  Activity doesn’t strengthen much further next year, either.  Even in 2014, GDP is expected to expand by less than 1.5% in the euro area, less than 1.0% in Japan, and less than 8.0% in China.  Over the three years 2012-14, economic growth is assumed to averaged 2.3% per annum in Canada and the United States, 7.8% per annum in China, 1.6% in Japan, 0.3% in Euroland and 3.2% in the world.

The Canadian economy is running only about 0.5% below its potential GDP growth trendline according to Bank of Canada estimates.  That’s a smaller output gap than most other economies are experiencing.  However, projected growth is low enough that the slack is not expected to be eliminated until the second half of next year.  Core CPI inflation is currently hovering around its 2.0% target and not expected to deviate by more than a tiny amount from that level over the coming 2.5 years.  The recent sizable drop in total inflation was caused by lower energy prices.  A further drop in total CPI to 1.2% is foreseen this quarter, and such should stay at 1.5% in the first half of 2013 before returning to 2.0% in the last six quarters of the forecast horizon.

An important assumption by Bank of Canada monetary officials is that the U.S. Congress greatly modifies the severity of next year’s fiscal cliff.  As a result, the perceived fiscal drag on GDP growth is a manageable 1.5 percentage point next year and again in 2014.  If Congress fails to take action, the drag would be four percentage points in 2013, posing serious dangers of a recession in North America. 

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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