Bank of Canada Didn’t Break New Ground

January 19, 2010

As analysts expected, central bank policymakers in Canada retained a target of 0.25% on overnight money and a 0.5% Bank Rate, and they reaffirmed a pledge not to raise those rates before the middle of this year, contingent upon an unchanged outlook for inflation.  Monthly short-term repo operations will continue through April to promote very low interest rates at the shortest end.  The inflation target is 2.0%, and officials expect headline and core inflation to be at 1.5% or slightly less until 4Q10 and not to return to 2.0% until 3Q11.  Moreover, a slight downwardly-biased risk surrounds this baseline forecast, so it is very doubtful that the outlook for inflation will change enough to warrant a rate hike before midyear.

The last cyclical peak on the overnight money target from July 2007 to early December of that year was at 4.5%.  The target was reduced by 25 basis points in December 2007 and January 2008 and by 50 bps each in March and April 2008.  After a six-month pause when energy cost pressures lifted inflation in Canada and elsewhere, two cuts of 50 bps and then 25 bps were implemented in October, followed by reductions of 75 bps in December, 50 bps each in January and March 2009 and a final 25 basis points last April.

The so-called output gap, which measures slack in the economy, is estimated at 3.25% last quarter after 3.5% in 3Q09 and is unlikely to get closed until the third quarter of next year.  Inflation tends to be subdued so long as there is slack in the economy, and when that is the case, it is possible for real GDP to expand more rapidly than its potential long-term trend without causing inflation to accelerate.  Once the economy reaches full employment, that will no longer be the case.

A statement released today also unveiled new economic growth projections, which are compared in the table below to those made last October, July and April.  Despite a smaller rise in GDP in 3Q than had been assumed earlier, projected growth remains essentially the same as before.

GDP Forecast Date 2010 2011
January 2010 2.9% 3.5%
October 2009 3.0% 3.3%
July 2009 3.0% 3.5%
April 2009 2.3% 4.7%


The central bank statement observes that recovery remains heavily reliant on policy stimulus and measures taken to alleviate financial market strains.  Positive growth has also been fostered by a higher terms of trade (export/import price ratio), stronger business and consumer confidence, and a somewhat stronger outlook for global growth than assumed back in October.  “Persistent strength in the Canadian dollar” was again cited as a growth and inflation suppressant.  Officials now believe that real GDP contracted 2.5% last year.

The central bank’s quarterly Monetary Policy Report will be published this Thursday, and its second interest rate policy statement of 2010 is scheduled to be made on March 2.

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



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