Review of Bank of Canada Monetary Policy Report

April 22, 2010

The 32-page quarterly policy report from Canada’s central bank reiterates many points made two days ago in the post-meeting policy announcement.  But a number of additional revelations were also imbedded in the report.  Here are some of the highlights.

  1. Real Canadian GDP at an annualized rate from the prior quarter is projected to have expanded 5.8% in the first quarter of 2010 and to grow 3.8% in 2Q10, and 3.5% in both 3Q and 4Q.  GDP in 4Q09 and 1Q10 were higher than imagined in the previous January policy report.
  2. Canada’s output gap, a gauge of excessive supply, peaked in the third quarter of 2009 and was still 2.3% last quarter by the conventional measure and around 2.0% when also taking account of other less conventional gauges of supply capacity.  This is smaller than envisaged three months ago.
  3. Core CPI inflation has been significantly higher than projected a year ago in spite of all the excessive capacityThis firmness reflects the resilience of wages in Canada’s service-sector industries and some significant increases of regulated administered prices.
  4. While longer-term expected inflation continues to be well-anchored at close to the 2.0% target, shorter-term price expectations have recently drifted upward and nearer to the target.
  5. Canadian financial conditions are now favorable, removing the need for extra support.  Household credit has been more robust than business credit.
  6. Canada’s potential GDP trend-line inclined 1.2% last year when actual GDP contracted 2.6%, resulting in a near-4% boost to economic slack.  In 2010, actual average GDP growth of 3.7% will exceed the rise in potential GDP by 2.2 percentage point (ppts), and a further 1.2 ppts of slack will disappear in 2011 when actual GDP rises 3.1% but potential GDP climbs only 1.9%.
  7. Some 35% of this year’s 3.7% growth in real GDP will stem directly from government spending, which will augment GDP by 1.3 ppts after last year’s contribution of 1.1 ppts.  Fiscal restraint produces a negative growth contribution from the public sector in both 2011 and 2012.
  8. Bank of Canada officials have penciled in U.S. growth of 3.1% in 2010 and 3.5% in both 2011 and 2012.  The euro area is projected to expand by 1.2% and 1.6% in 2010 and 2011, and Japanese growth in those years is put at 2.1% and 1.7%.  But world growth is robust at 4.2% this year, 4.0% next year and 4.1% in 2012.  Commodity prices accordingly stay firm throughout the period, but officials have assumed only a steady CAD/USD near par.
  9. A fairly sharp slowdown of Canadian GDP growth to 1.9% occurs in 2012.  By no accident, that just happens to match exactly the projected rise of GDP that year.  Canada’s present output gap of 2-2.3% disappears in the second quarter of 2011, which means that faster-than-trend economic growth beyond that point would be inflationary.  Officials back into their policy guidance by knowing that real GDP mustn’t be allowed to exceed 1.9% in 2012.
  10. Although not stated explicitly, the mechanism for slowing down economic growth to marginally less than 2% in 2012 will be budget cutbacks and higher Canadian interest rates.  Since monetary policy works with a lag of upwards of a year, the time to start raising interest rates will be at the next scheduled meeting in early June.
  11. The report ends with a warning that global current account imbalances, a root cause of the world recession, are again widening and urges deficit countries to consolidate fiscal shortfalls and surplus countries to enact policies that stimulate domestic demand and promote real exchange rate gains.
  12. Risks to the Bank’s baseline forecast of Canadian inflation are deemed to be balanced but sizable in both directions.  The path of monetary stimulus withdrawal will be determined by the evolution of activity and price data.  In any case, the Bank of Canada is prepared to become the first G-7 central bank that raises its benchmark interest rate.

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



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