Bank of Canada Preview

January 18, 2010

When the last Bank of Canada overnight rate target cut was implemented last April, a 25-basis point reduction to 0.25%, officials projected that “conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of the second quarter of 2010 in order to achieve the inflation target” of 2.0% in the medium term.  That promise has been repeated in each statement released after ensuing policy meetings.  So it will be with the first statement of 2010, due at 14:00 GMT Tuesday. 

Of greater interest will be new quarterly growth and price forecasts that are also due.  In October, officials had projected GDP growth of 3.0% in 2010 and 3.3% in 2011, and they did not expect total or core inflation to climb back to 2.0% until the third quarter of 2011.  The October statement also warned that “the current strength in the Canadian dollar is expected over time to more than fully offset the favorable developments [in domestic demand and world growth] since July.”  Officials were too optimistic three months ago about third-quarter GDP growth, projecting a 2.0% annualized increase and a drop of 2.8% from 3Q08.  Instead, as net exports exerted an annualized drag of 5.27 percentage points, GDP firmed just 0.4% last summer and recorded a 3.2% on-year drop. 

GDP did not get off to a fast start in the fourth quarter, firming just 0.2% in October as industrial production firmed just 0.1% and was 12% lower than in October 2008.  Back in October, Bank of Canada officials were assuming that 4Q09 would see real GDP advance 3.3% at an annualized rate.  That seems too high, and so does the 3.0% increase projected for 2010 as a whole.  Canada’s economy has considerable slack.  Capacity usage in 3Q09 was 67.5%, two-tenths less than in 2Q09 and down from 78.9% in 3Q08.  312K private employee jobs were shed last year, a drop of 2.8%, whereas the labor force expanded by 118K.  The unemployment rate of 8.5% in December was 1.9 percentage points greater than a year earlier. 

The Canadian dollar remains under upward pressure, having climbed 3.0% against the U.S. dollar since Bank of Canada policymakers last met in early December.  November trade figures served as a reminder that exchange rate appreciation can make Canada’s economic recovery even more gradual and delay the point when inflation returns to target.  The November trade position unexpectedly swung back into deficit (C$ 344 million) as a 3.9% leap in imports eclipsed a 1.1% monthly advance in exports.  The November readings on total and core consumer price inflation were 1.0% and 1.5%, the latter being down from 1.8% in October.  Unit labor costs in 3Q09 were 0.1% less than in the second quarter and up just 2.5% from a year before, and producer prices in November were 2.7% lower than a year earlier.  A 6% drop of motor vehicle sales in November undid improvement seen in July-October.  A bright spot in the Canadian economy has been housing, but the Finance Minister has said there is no housing bubble.

Since the last Bank of Canada meeting, oil prices have risen 8%, and the 10-year Canadian bond yields has climbed 20 basis points on balance, a shade less than the yield on the U.S. 10-year Treasury note.  The message in tomorrow’s Bank of Canada communique will be that policy intentions remain as they wereThe disappearance of slack in the economy is apt to be moved another quarter deeper into the future, but officials will be hopeful that the return to positive economic growth will continue, albeit at a gradual pace considering how rapidly activity contracted previously.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.



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