Bank of Canada Keeps Four-Year-Old Policy Settings But Shares New Kernels of Wisdom

October 22, 2014

The monetary policy interest rate target has been at 1.0% since a 25-basis point hike in September 2010.  Following a quarterly review, that level is still considered appropriate, according to a statement released today.  The statement and accompanying Monetary Policy Report convey numerous insights into the latest thinking of Canada’s monetary policymakers.

  • Canada’s output gap is believed to have been between 0.5% and 1.5% in the third quarter of 2014.  Such is not expected to be fully eliminated until the second half of 2016, and only then once full capacity has been attained will inflation of 2.0%, the target, be sustained.
  • Real GDP in Canada is projected to average 2.4% next year, 2.3% in the first half of 2016 and then decelerate to 2.1% in 3Q16 and 2.0% in the final quarter of 2016.  These rates are expansion are only slightly faster than the 2.0% estimated growth rate of potential GDP.  Reductions in the economy’s slack or unused capacity depend on faster actual than potential growth.
  • The growth prognosis has been affected by some new factors since the prior Monetary Policy Report released in July.  The terms of trade (export/import price ratio) is expected to be 6% lower, which will exert a 0.25 percentage point drag on economic growth.  A weaker Canadian dollar, averaging 89 cents instead of 93 cents as thought in the July Report, will boost exports and add about 0.1-0.3 ppts to core inflation.
  • It is assumed that global economic growth accelerates from 3.1% this year to 3.4% in 2015 and 3.5% in 2016.  That strengthening momentum masks downward revisions in projected growth from 3.7% in 2015 and 3.8% in 2016 that had been assumed in the July Report.  Projected growth in the euro area in 2015 was revised to 0.8% from 1.4% and will not exceed 1.0% even in 2016. 
  • Total CPI inflation climbed to around 2% faster than bank officials had expected, but that surprise is offset by lower energy prices. 
  • Growth in Canada and other economies continues to be highly reliant on “exceptional policy stimulus.”  In the absence of U.S and Canadian monetary stimulus, officials estimate that Canada now would have an output gap equal to 5.5% of GDP and core CPI inflation well below 1.0%.
  • Canada’s neutral policy interest rates (1-2% adjusted for inflation and 3-4% in nominal terms) are more than a full percentage point less they such were in the mid-2000s.

Officials are not addressing the timing of the next interest rate hike.  But it will clearly happen well before they expect the output gap to be closed entirely.  By that point, it will be desirable to have the interest rate much closer to neutrality — that is, neither promoting faster or slower economic growth — than it is now.  Today’s statement explicitly calls the 1.0% interest rate level, which like some 75 basis point above the fed funds target ceiling, appropriate.

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

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