Later Onset of Rate Increases Signaled by the Bank of Canada

April 17, 2013

From a low of 0.25%, the target Canadian overnight rate was lifted three successive times in June, July and September 2010, but no further rate normalization has been engineered during the ensuing 31 months.  The key rate will remain at 1.0% according to today’s third scheduled policy announcement of 2013, which was synchronized with the publication of a fresh quarterly Monetary Policy Report.  The Bank of Canada is led by Mark Carney, who is slated to change governorships to lead the Bank of England effective in July.

Bank of Canada officials repeatedly overestimated economic growth in 2012.  GDP grew only 0.6% at an annualized rate in the final quarter, for example, which was about half as much as projected in January’s Monetary Policy Report.  The latest forecasts revised down projected growth in the first quarter of 2013 to 1.5% from 2.3% and for 2Q13 to 1.8% from 2.7%.  Exports are no projected to rise as high as the pre-recession peak until the second quarter of next year, and “the persistent strength of the Canadian dollar” is one reason for that slow revival.  Balance sheet issues among households will limit personal consumption to a moderate pace, and residential investment is seen falling.

Typical of earlier forecasting patterns, a further acceleration of the expansion to 2.5% is expected in the second half of this year and to plateau at 2.7-2.8% in 2014-15.  Whether this more normal pace happens remains to be seen, but in any case Canada finds itself with much more resource slack now than officials had assumed earlier, and that has important interest rate policy implications.  The restoration of full capacity is now unlikely, according to officials, until mid-2015.  The timing has been pushed back from a prediction of 2H14 made in January, end-2013 made last October and mid-2013 believed back in July.  Analogously, the likely next increase of the overnight money rate to 1.25% has been delayed by 18-24 months as well in the space of the last nine months.

CPI inflation has accordingly is “expected to remain subdued in coming quarters,” restrained by low core inflation and declining mortgage interest rates.  The projected floor in on-year consumer price increases of 0.9% occurs in the first quarter of this year, but the subsequent expected inflation path has been revised lower than the predictions in January for every quarter from 2Q13 through 1Q15.  Only in the second quarter of 2015 does such return to the 2.0% target.  Interestingly, the modified inflation forecast is barely related to energy.  Oil prices are seen on a very similar path as the one assumed in the January Report.

With continued slack in the Canadian economy, the muted outlook for inflation, and the constructive evolution of imbalances in the household sector, the considerable monetary policy stimulus currently in place will likely remain appropriate for a period of time, after which some modest withdrawal will likely be required, consistent with achieving the 2 per cent inflation target.

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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