By CentralBankNews.info
Canada’s central bank maintained its target for the overnight rate at 0.75 percent, as widely expected, saying the “risks to the outlook for inflation are now roughly balanced,” a slight chance in wording from last month when it said the risks around inflation were “more balanced” following the surprise 25 basis points rate cut in January.
The Bank of Canada (BOC) said the negative impact of the decline in oil prices on economic activity was now appearing even sooner than it expected in January though looking at the next two years the overall drag on the economy will be the same.
The forecast for economic growth this year was trimmed to 1.9 percent from January’s forecast of 2.1 percent, mainly because investments will be lower, but for 2016 the growth estimate was revised up to 2.5 percent from 2.4 percent as exports jump. For 2017 the BOC forecast 2.0 percent growth.
“The Canadian economy is estimated to have stalled in the first quarter of 2015,” said the BOC, adding that the shift toward stronger non-energy exports, rising investment and improving labor markets was fueled by easier financial conditions and improving U.S. demand.
With the effects of the oil price shock waning, Canada’s economic growth is projected to rebound in the second quarter of this year. In the fourth quarter of 2014 Gross Domestic Product rose an annual 2.63 percent.
The BOC’s forecast for 2015 is more pessimistic than that from the International Monetary Fund, which this week cut its 2015 growth forecast to 2.2 percent from its January forecast of 2.3 percent. However, for 2016 the BOC is more optimistic as the IMF only forecast growth of 2.0 percent, down from its January forecast of 2.1 percent.
Exports from Canada’s manufacturing sector – such as aircraft, machinery and pharmaceuticals – are benefitting from the decline in the Canadian dollar against the U.S. dollar. However, the flip side of a lower Canadian dollar is that it costs more to borrow in U.S. dollars, hitting investments.
The Canadian dollar, known as the loonie, tumbled against the U.S. dollar in the second half of last year, not only reflecting the strength of the U.S. economy, but also confirming the Canadian currency’s historical relationship with oil prices.
In its monetary policy report, the BOC said the Canadian dollar was assumed to be close to its recent average level of 79 cents over the projection horizon compared with 86 cents assumed in January. Today the loonie was at 80 U.S. cents compared with 86 cents at the start of the year.
Weak economic activity in the first three months of this year has widened the economy’s output gap, putting additional downward pressure on inflation. However, the expected recovery in growth means the output gap will be back in line with the forecast so the effect on core inflation from the lower dollar and the output gap will continue to offset each other, the BOC said.
In February Canada’s headline inflation rate was unchanged at 1.0 percent but as the economy reaches full capacity around the end of 2016, the BOC expects total and core inflation to be close to its 2.0 percent target. Total consumer price inflation is forecast to reach 1.4 percent by the fourth quarter of this year and then 2.0 percent by the end of 2016.
The Bank of Canada issued the following statement:
Canada holds rate, risks to inflation roughly balanced
April 15, 2015
“The Bank of Canada today announced that it is maintaining its target for the overnight rate at 3/4 per cent. The Bank Rate is correspondingly 1 per cent and the deposit rate is 1/2 per cent.
Total CPI inflation is at 1 per cent, reflecting the drop in consumer energy prices. Core inflation has remained close to 2 per cent in recent months, as the temporary effects of sector-specific factors and pass-through of the lower Canadian dollar have offset the disinflationary forces from slack in the economy.
The Bank expects global growth to strengthen and average 3 1/2 per cent per year over 2015-17, in line with the projection in the January Monetary Policy Report (MPR). This is in part because many central banks have eased monetary policies in recent months to counter persistent slack and low inflation, as well as the effect of lower commodity prices in some cases. At the same time, economies continue to adjust to lower oil prices, which have fluctuated at or below levels assumed in the January MPR. Strong growth in the United States is expected to resume in the second quarter of 2015 after a weak first quarter.
The Canadian economy is estimated to have stalled in the first quarter of 2015. The Bank’s assessment is that the impact of the oil price shock on growth will be more front-loaded than predicted in January, but not larger. The ultimate size of this impact will need to be monitored closely. Underneath the effects of the oil price shock, the natural sequence of stronger non-energy exports, increasing investment, and improving labour markets is progressing. This sequence will be bolstered by the considerable easing in financial conditions that has occurred and by improving U.S. demand. As the impact of the oil shock on growth starts to dissipate, this natural sequence is expected to re-emerge as the dominant trend around mid-year. Real GDP growth is projected to rebound in the second quarter and subsequently strengthen to average about 2 1/2 per cent on a quarterly basis until the middle of 2016. The Bank expects real GDP growth of 1.9 per cent in 2015, 2.5 per cent in 2016, and 2.0 per cent in 2017.
The very weak first quarter has led to a widening of Canada’s output gap and additional downward pressure on projected inflation. However, the anticipated recovery in growth means that the output gap will be back in line with its previous trajectory later this year. Consequently, the effects on core inflation of the lower dollar and the output gap will continue to offset each other. As the economy reaches and remains at full capacity around the end of 2016, both total and core inflation are projected to be close to 2 per cent on a sustained basis.
Risks to the outlook for inflation are now roughly balanced and risks to financial stability appear to be evolving as expected. The Bank judges that the current degree of monetary policy stimulus remains appropriate and therefore is maintaining the target for the overnight rate at 3/4 per cent.”
