12 Apr

Bank of Canada Upgrades Forecast, But Keeps Rates Unchanged


Posted by: Tony Passalacqua

For years now, the Governor Stephen Poloz and his Bank of Canada colleagues have held the key overnight rate unchanged at 1/2 percent, while at the Federal Reserve has hiked rates several times with more to come. The jobless rate is at a mere 4.5 percent in the US, clearly at or near full employment and the Fed policy makers have suggested they will reduce liquidity further this year and next. Once again today, the Bank of Canada has held the key overnight rate steady while upgrading their outlook for the economy.

Economists now expect the Canadian economy to grow at a rate of roughly 2.5 percent, compared to 1.4 percent last year and a mere 0.9 percent the year before. Indeed, economic activity has accelerated sharply since the middle of last year–up at a 4.3 percent annual pace over that seven-month period. Job creation has been strong since the summer. The Business Outlook Survey suggests that business investment–a disappointing underperformer–is poised to rise as the oil sector digs itself out of the rut caused by the collapse in oil prices in mid-2014. Export growth accelerated sharply until February, which hopefully is a one-month aberration and housing activity certainly remains strong–too strong in the Greater Toronto Area and its environs, as well as in parts of British Columbia.

No one expects the Bank of Canada to raise rates simply because of the housing market, as housing markets are not overheated in much of the rest of the country.

In today’s Monetary Policy Report (MPR), the Bank boosted their forecast of Canada’s economy this year to 2.6 percent from 2.1 percent in the January MPR. For 2018, growth is now projected to be 1.9 percent (slightly below the January forecast). However, the Bank suggested that the “composition of aggregate demand is uneven.” According to today’s MPR, “In the oil and gas sector, a resumption of growth in investment spending is under way in the wake of significant adjustments to past declines in commodity prices. This contributed, together with very strong consumption and residential investment, to a temporary surge in growth in the first quarter. In contrast, non-commodity business investment and exports remain weak, raising questions about the medium-term sustainability of the upturn”.

“Economic activity will be supported by rising foreign demand, federal fiscal stimulus and accommodative monetary and financial conditions. In addition, the composition of demand growth is expected to broaden: the pace of household expenditures, especially residential investment, moderates as the contributions from exports and business investment increase, albeit at a much slower pace than would normally be expected at this stage of the cycle. Ongoing competitiveness challenges and uncertainty surrounding the prospects for global trade are expected to limit this broadening of growth. A notable increase in global protectionism remains the most important source of uncertainty facing the Canadian economy”.

The Bank’s forecast remains a bit below the consensus view of Bay Street economists. The Bank has underestimated growth for many quarters. The MPR suggests that “while the degree of excess capacity has declined since the January Report, the Bank judges that in the first quarter of 2017 it remains material, between 1 1/4 and 1/4 per cent”. The output gap is now projected to close in the first half of 2018, a bit sooner than the Bank anticipated in January.