GROWTH OUTLOOK

The Bank of Canada leaves overnight rate unchanged and 2011 growth outlook revised modestly higher


As was almost universally expected, the Bank of Canada left the overnight rate unchanged at 1.00% for the third meeting in a row and followed a string of three meetings where it opted to raise rates 25 basis points each time from a recessionary trough of 0.25%. Steady policy was largely a reflection of little change in the economic outlook. As expected, growth for 2011 was revised up although by a minimal 0.1 percentage point (pp) to 2.4%. Inflation expectations were characterized as remaining “well-anchored”.

With no move on interest rates expected coming out of this meeting, attention was more focused on the statement issued following the meeting to provide clues as to any eventual shift in policy. What was most widely expected was a likely upward revision to growth in the wake of some aggressive stimulative measures in the US that are expected to boost growth in that economy. In the statement, the Bank of Canada acknowledged that “private domestic demand in the United States has picked up and will be reinforced by recently announced monetary and fiscal stimulus.” In the end, however, the Bank of Canada opted to notch up 2011 growth only 0.1 pp to 2.4% from 2.3% previously. Growth in 2012 was raised to 2.8% from 2.6%.

The release on Wednesday (January 19, 2011) of the Monetary Policy Report (MPR) will provide more details of the revised outlook. Of interest will be the extent that U.S. 2011 growth has been revised up relative to a current forecast of 2.3%. On the surface, the upward revision to Canada implies growth in the US has only been revised to around 2.5%. This amount implies a fairly modest effect from the fiscal and monetary policy stimulus recently introduced. Our current U.S. growth this year is 3.4% with recent consensus numbers indicating expected growth of 3.2% for 2011.

The upward revision to Canadian growth this year and next did not alter the central bank’s view on the output gap closing by the end of 2012. The offset was “a little more excess supply in the near term.” This statement is likely a reference to growth in the second half of 2010 coming in below the Bank’s forecast of 1.6% and 2.6% in third and fourth quarters of 2010, respectively. The actual third-quarter 2010 growth rate was 1.0%, and we are currently monitoring a fourth-quarter gain of 2.3%. Tomorrow’s MPR will provide further clarification of the source of this addition of near-term excess supply.

The stronger U.S. outlook contributed to global growth improving slightly faster than the Bank of Canada had anticipated; however, this also reflected stronger growth in Europe although the central bank cautioned that sovereign and bank balance sheet issues in the region continue to be a source of uncertainty. With respect to emerging markets, it was noted that more restrictive policy measures were being introduced in the region implicitly to counter stronger than desired growth.

The description of the Canadian economy was marginally more upbeat as it acknowledged “the beginning of the expected rebalancing of demand.” This statement referred to the increased role of business investment to support growth near term as fiscal stimulus unwinds and household spending continues to be constrained by overextended balance sheets.

Comments on the currency were limited to a reference to its “persistent strength” that was restraining the recovery in net exports.

As expected, the Bank of Canada opted to hold the overnight rate steady at 1.00%. This result occurred despite an acknowledgement of slightly stronger growth in both the US and globally along with some optimism about the “beginning of the expected rebalancing of demand” in Canada. The Canadian growth outlook was revised up as a consequence although by a minimal 0.1 pp this year and 0.2 pp for 2012. These minimal changes to growth did not alter the expected closing of the output gap by the end of 2012 because of weaker growth in the second half of 2010 and thus provided the strongest justification for unchanged policy. Our view, however, is that growth will likely come in stronger than expected this year. As it becomes more evident in the data, we assume a return to tightening mode by the second quarter of 2011. Low inflation will not prevent further tightening, yet it will keep the pace of tightening gradual with the overnight rate rising to only 2.00% by the end of 2011.

Paul Ferley, Assistant Chief Economist, RBC Economics