Bank of Canada Monetary Policy Report Highlights

January 19, 2011

The quarterly Bank of Canada Policy Report is loaded with useful information about how central bankers in this and other countries may view conditions and prospects in the Canadian and global economies.  Compared to October when the previous Policy Report was compiled, Canadian growth and inflation prospects hardly changed.  Projected real GDP growth in 2011 was bumped up to 2.4% from 2.3%, and that for 2012 got revised from 2.6% to 2.8%.  Central bank officials still anticipate a return to full capacity around the end of 2012 and for both core and total CPI inflation to climb back to the targeted 2.0% at that same time. The estimated size of Canada’s output gap of 1.75% — that is the shortfall of actual GDP from GDP if productive resources were fully utilized — is the same as assumed in the October report about the third quarter of 2010.  An output gap near 2% generally implies pretty significant demand-pull disinflation.

Digging deeper into the 37-page report, one encounters some significant findings.  Here are some of the highlights.

  • Projected U.S. GDP in 2011 has been revised upward by a whole percentage point to 3.3% from 2.3% predicted three months ago.  Smaller but upward adjustments were made of 0.4 percentage points (ppts) in projected 2011 Euroland growth, 0.3 ppts in Chinese growth, 0.1 ppt in Japanese growth and 0.4 ppts for collective growth in all other regions.  The U.S. expands somewhat more than twice as fast as the euro area and Japan this year.
  • The favorable impact on Canadian growth of recent U.S. fiscal and monetary stimulus measures is expected to reach 0.2 ppts in 2011 and 0.1 ppt in 2012.
  • Assumed global growth has been bumped up by a half-ppt to 4.0% in 2011 and is seen averaging 4.3% per annum over the three years 2010-2012.
  • Canadian business investment and exports remain well below their pre-recession levels in 3Q08.  However, a substantial rotation of Canadian growth towards those two sources of demand has begun.  In 2010, consumption, housing, government expenditures and inventories accounted for 4.6 percentage points of real GDP growth, but that impetus will shrink to 1.2 ppts this year and 0.9 ppts in 2012.  In contrast, net exports and business investment, which exerted a 1.7-ppt drag on GDP last year, is forecast to enhance such by 1.2 ppts in 2011 and 1.9 ppts in 2012.
  • A revival of business investment over the coming two years will help productivity pick up.  Canadian output per man-hour has floundered badly in recent years.
  • Because of the substantial amount of remaining slack in Canada’s economy, on-year core inflation is likely to be below the 2.0% target through the third quarter of 2012 and only return to target in the final quarter of the relevant policy time horizon.  Total consumer price inflation is slightly greater than 2.0% at present because of temporary factors like higher federal and provincial indirect taxation and elevated prices for oil and other commodities.  Total CPI is forecast to dip below 2% again after mid-2011.  Total and core inflation have identical quarterly profiles in 2012.
  • Huge risks are associated with the baseline inflation forecast, so the future policy path is far from sealed.  But with information now available, a need is seen for retaining “considerable monetary stimulus in place,” lest inflation not climb all the way back to 2% even as far away as the final quarter of next year.  The main identifiable risks to inflation, while very large, are also deemed balanced.  One area of great uncertainty concerns household consumption.  The report mentions “greater-than-projected momentum in the household sector” as a major upside price risk but turns around and lists “weaker-than-projected household expenditures” as a possible key downside price risk factor.

It looks as if Canadian monetary officials will at least wait longer than their next policy meeting on March 1 before lifting the 1.0% target on overnight money.  Several factors point to very subdued inflation ahead.  For one thing, the new forecasts show that’s what Bank officials are assuming.  For another, elevated commodity prices should buoy the Canadian dollar.  West Texas Intermediate oil prices are now forecast to average $93.50 this year and $95 in 2012, up from a prior assumption of $86 this year and $88 in 2012. Canadian commodity prices are 14% higher than they were just three months ago.  A strengthening Canadian current account and improving productivity are other factors pointing to an appreciating exchange rate.  A third reason to maintain monetary looseness is that fiscal policy is getting tightened this year, and a fourth is the existence of downside risks factors to global growth such as the possible need for a sharper-than-assumed slowdown of Chinese growth to cut inflation and the ever-present risk that Euroland’s debt crisis takes a nasty turn for the worse. 

The Bank of Canada’s Report, like the interest rate statement released yesterday, concludes that “any further reduction in monetary policy stimulus would need to be carefully considered.”

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.



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