Bank of Canada to Tighten Later than Imagined Earlier

January 23, 2013

Canada’s overnight interest rate target, which has been at 1.0% since a 25-basis point hike in early September 2010, was left at that level and accompanied by a statement that declared “any such modest withdrawal of monetary policy stimulus is less imminent than previously anticipated.” 

The more dovish picture reflects downward revisions to GDP growth in every quarter starting with1Q12 and running through 1Q13.  Cumulative growth over that five-quarter span is now projected to be 1.8%, down from 2.5% assumed in the October Monetary Policy Report.  As a result, a new MPC released today postulates that productive resources will not be employed fully before the third quarter of next year at the earliest instead of by the end of this year as assumed in the October MPR.  Because of greater perceived slack in Canada’s economy, core inflation is now lower than assumed previously.  Weaker-than-projected gasoline prices have additionally depressed overall CPI inflation, which is now projected to average 1.0% in the first half of 2013, that is just barely at the bottom of the central bank’s target range.  The October MPR had projected total CPI rising to the target mid-point of 2.0% by the final quarter of 2013 and remaining at that level for the rest of the projection horizon.  But now, total CPI inflation averages 1.65% in the second half of 2013 and 1.85% in the first half of 2014, getting back to the target midpoint no sooner than 2H14. 

An even starker revision of the forecast involves core CPI, which previously was thought likely to reach 2.1% by this year’s third quarter but now peaks at 2.0% a year later than that.  A continuing disinflationary force involves the overvalued Canadian dollar, and exports are not seen recovering to their pre-recession peak before sometime after mid-2014. 

There are some paradoxes in Canada’s economic circumstances. 

  • Global tail risks to growth have diminished, but the baseline forecast of the global economic outlook, a GDP advance of 2.9% in 2013, is slightly lower than prior assumed 3.1% increase.  Most of this downgrade involves the euro area, which is now expected to contract by 0.3% instead of expanding 0.4%.  Projected U.S. growth has been lowered 0.2 percentage points to 2.1%.
  • Canadian officials consider risks to the inflation outlook to be “significant,” yet balanced. The possibility that inflation could exceed forecast by a sizable margin, plus the baseline view that inflation will be trending higher in the medium term, are sufficient to retain the directional guidance that policy in the medium term is likely to become less accommodative. 
  • Excessive economic slack will not be restored until at least a half-year later than projected in October, despite the assumption that actual Canadian GDP expands in 2013 by 2.0% and in 2014 by 2.7%.  The shifting view on economic slack stems primarily from historical revisions.  In October, officials said Canada’s output gap (the percent difference between actual GDP and hypothetical GDP at full employment) was negative 0.66% in September but now believe such was a larger, not smaller, negative 1.0% by the end of 2012.  Since potential GDP is set to advance 2.1% in 2013, the output gap is unlikely to shrink more than marginally before the start of 2014, a year when actual GDP climbs a 0.5 percentage point faster than potential GDP.
  • The Canadian dollar has not relinquished its pricey level in spite of a swing of the current account from a 3% of GDP surplus in late 2005 to a 4% of GDP deficit now.

The next policy statement is scheduled for March 6.

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



One Response to “Bank of Canada to Tighten Later than Imagined Earlier”

  1. Hedge Mike says:

    At first reading this I did not know what to expect, but I am glad the way it finishedThanks for sharing…