Bank of Canada Keeps 1.0% Overnight Interest Rate Target, Calling Policy Stance Appropriate

April 16, 2014

The third scheduled interest rate announcement of 2014 coincided with the release of a new Monetary Policy Report.  Estimates for 2016 have been added to the Bank of Canada’s macroeconomic forecasts.  While core inflation is seen hovering at 1.2% in the first half of this year and not returning to the 2.0% target until the first quarter of 2016 after a gradual climb, the path of total CPI inflation was raised by 0.4 percentage points for each quarter of 2014 versus estimates released in January of this year.  Total CPI is forecast staying at 2.0% thereafter.  Higher energy costs and recent C-dollar depreciation account for this more elevated total inflation path.  Core inflation eventually converges on the 2.0% total CPI trendline because of a diminishing output gap that sees full employment conditions restored around the end of 2015.  Also, heightened competition in the retail sector, which is currently subtracting 0.3 percentage points from core inflation, will fade gradually.  While potential GDP is forecast to advance at a pace of 2.0% per year over the projection horizon, real GDP is seen likely growing by 2.5% this year and next before scaling back to 2.0% in 2016. 

The above baseline scenario is associated with both upside and downside risks that are more or less balanced.  Among the risks are stronger growth in U.S. domestic demand, a continuing underperformance by Canadian exports, significant imbalances in households, and sever tightening of credit conditions in emerging market economies.  Finally, the long period in which core inflation stays below target is itself a downside price risk factor not to be ignored.

The Bank of Canada’s overnight target has been 1.0% since a 25-basis point hike in September 2010, which followed similar-sized increases in June and July of that year.  Today’s policy decision statement, like those in March and January, is noncommittal about the direction of the next interest rate change: “The timing and direction of the next change to the policy rate will depend on how new information influences this balance of risks.” 

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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