Bank of Canada Preview: No Rate Change Likely

October 22, 2012

The penultimate pre-scheduled interest rate announcement of 2012 will be made at 09:00 EDT on Tuesday.  The overnight interest rate target has been at 1.0% since September 2010, but the previous four statements in April, June, July and September set an upwardly biased future guideline:

To the extent that the economic expansion continues and the current excess supply in the economy is gradually absorbed, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate, consistent with achieving the 2 per cent inflation target over the medium term. The timing and degree of any such withdrawal will be weighed carefully against domestic and global economic developments.

The conditions for acting on that tightening bias are not yet in place.  In fact, the central bank plausibly will be revising down projected growth again.  In July, officials trimmed the forecast for 2012 to 2.1% from 2.4% and the forecast for 2013 to 2.3% from 2.4.  A full update of the Bank’s outlook for the economy and inflation, including risks to the projection, is being published on Wednesday.  Recent economic tea leaves present a mixed picture.  Employment jumped 3.0% at an annualized rate between July and September, but merchandise exports dipped 0.1% in August and swooned by 3.7% from a year earlier.  Exports of industrial goods and materials sank 6.1% between July and August, and automotive shipments declined by 2.3%.  Retail sales and wholesale turnover are holding up pretty well.  The manufacturing purchasing managers index printed 0.6 points lower in September at 52.4, indicating a slower pace of expansion.  In the second quarter, real GDP advanced 1.8% at an annualized rate, a half percentage point faster than U.S. GDP but not quickly enough to shrink Canada’s output gap.

Another reason not to raise the overnight interest rate now is recently subdued Canadian inflation.  Compared to a medium-term target of 2.0%, consumer prices rose just 1.2% between 3Q11 and 3Q12.  Core inflation was unchanged on month in September and slowed to a 12-month increase of 1.3% from 1.6% in August and 1.7% in July.

Fiscal policy that stresses budget deficit reduction creates leeway to maintain considerable monetary stimulus.  The shortfall in 2Q was only C$ 2 billion, strongly suggesting a smaller imbalance than targeted this fiscal year.

And finally, near-term U.S. growth risks are skewed to the downside, as fiscal cliff deadlines draw very near.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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