April 17, 2012
Data Release: Bank of Canada takes a more hawkish tone:
As widely anticipated, the Bank of Canada announced that it will hold the overnight rate at 1.0%, but signaled that an interest rate hike may come earlier than markets are anticipating. The Bank of Canada judges that given improved global and Canadian economic conditions, there is less slack in the Canadian economy than was anticipated and “some modest withdrawal of the present considerable monetary policy stimulus may become appropriate”.
The Bank of Canada revised up its outlook for the Canadian economy. The Bank expects the economy to grow by 2.4% in 2012, up from the forecast of 2.0% in January’s MPR. While the Bank revised its growth outlook for 2013 down to 2.4% (from a previous 2.8%), stronger economic growth this year is likely going to help the economy absorb excess slack earlier than anticipated, with the output gap now expected to close in early 2013 – compared to late 2013 in January’s MPR. As a result, inflation is expected to remain firmer than was expected, but still hover around the Bank of Canada’s 2.0% target.
While the revision in part reflects continued robust activity in emerging markets and a more entrenched U.S. recovery, the Bank of Canada expects that business investment and household spending will do most of the heavy lifting over the next few years.
The Bank highlighted three key risks to the outlook. First, while Europe is expected to emerge from recession in the second half of 2012, the Bank highlighted that major risks surround that outlook. Second, there are risks surrounding the threat from high commodity prices. And, last but certainly not least is the risk of rising Canadian household debt.
This morning’s Bank of Canada announcement suggests that Canadian interest rates are going to rise sooner than was anticipated, but the extraction of monetary stimulus is likely to remain gradual. The language of the communiqué makes a rate hike by the end of 2012 highly likely, but the timing in still uncertain. The last time the Bank of Canada signaled an upcoming rate hike, it took a few meetings for it to follow through.
The change in language does not come as a shocking surprise. While Canadian economic growth was choppy over 2011, real GDP likely grew at an average close to 3.0% over the second half of 2011 and first quarter of 2012 – a pace of economic growth that is well above trend. In addition, keeping rates this low with a well functioning banking system will only help contribute to the household debt problem building in Canada – a risk that the Bank of Canada Governor has warned against in many speeches and one that he has recently communicated a willingness to lean against.
Still, there are reasons to remain cautious. Risks in Europe remain high. With worries around Greek debt out of the way for now, focus has shifted to Spain. In addition, the Bank of Canada remains more optimistic on economic growth, particularly domestic spending, than TD Economics. We anticipate the Canadian economy will grow by 2.2% in 2012 – a speed of economic growth that is consistent with the output gap closing in mid-2013 – slightly later than the Bank of Canada’s view.
Overall, a more compelling argument has been building for the extraction of monetary stimulus, but the pace of rate hikes will likely be gradual. We anticipate that despite the change in language in this morning’s announcement, rates will remain lower than normal for some time.
Diana Petramala, Economist
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