Bank of Canada cuts forecast again, sees higher rates

The Bank of Canada once again predicted on Wednesday a delayed return to desired economic growth rates, but it left interest rates unchanged and repeated that at some point it would probably tighten monetary policy.

"With continued slack in the Canadian economy, the muted outlook for inflation, and the constructive evolution of imbalances in the household sector, the considerable monetary policy stimulus currently in place will likely remain appropriate for a period of time, after which some modest withdrawal will likely be required...," the central bank stated.

In the last Monetary Policy Report before Governor Mark Carney leaves for the Bank of England, the central bank sharply downgraded growth expectations for the first and second quarters to below its 2.1 percent estimate of potential growth, meaning slack was continuing to grow.

It figured the spare capacity grew to 1-1/4 percent in the first quarter from the one percent it saw in January for the fourth quarter of 2012.

As a result, it will take longer for the economy to hit full capacity and for total and core inflation to rise to the bank's 2 percent target. It now sees this happening by mid-2015, whereas in January it had predicted the second half of 2014.

It cut its prediction for 2013 growth to 1.5 percent -- matching this week's International Monetary Fund forecast -- from the two percent it saw in January, and hopes for 2.8 percent growth in 2014.

The culprits for the lower growth this year are downward revisions to growth in government spending, more contraction in housing than forecast, and less-than-expected business investment. It saw signs that factors weighing on business investment were "likely to persist for some time."

Despite the decline in residential investment from historically high levels, the bank still registered concern about the once-torrid housing market: "There are still some signs of overbuilding, particularly of multiple-unit dwellings in some urban areas...Valuations in some segments of the housing market remain stretched."

Concern over housing is one reason Carney has not dropped the bank's year-long tightening bias as some economists have suggested. But the insistence that the next movement in interest rates is likely up rather than down has also boosted the Canadian dollar.

The bank said the currency's persistent strength was influenced by safe-haven flows and spillovers from global monetary policy, and this continued to restrain export growth.

Canadian inflation has long been below the two percent target: overall inflation was 1.2 percent in February. The Bank of Canada said that in addition to spare capacity, inflation was subdued by competitive pressures on retailers.

Among those pressures, it noted the expansion of big-box stores, the arrival of large U.S. retailers, and increased online and cross-border shopping, stimulated by the strong Canadian dollar.

Louise Egan, Reuters
10:00 AM, E.T. | April 17, 2013
Canadian, Economy


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