Canada’s economy has gone from being the envy of the Group of Seven to one that won’t be running at full tilt until a year later than previously believed.
As consumers retrench to trim their debt loads and the rebound in the country’s main export market seems trapped in a straitjacket, Bank of Canada Governor Mark Carney and his rate-setting panel kept their benchmark interest rate at 1 per cent Tuesday after three consecutive increases. They also provided a preview of a gloomy new forecast the central bank will release Wednesday.
Canada is being pulled down by a U.S. recovery that will be weaker than projected, a global turnaround that is “entering a new phase” fraught with uncertainty, and a retrenchment by Canadian consumers, the central bank said in a statement on the decision. The tone reinforced the view of most economists that the bank could hold interest rates steady well into next year, as did a line saying “currency movements” could restrain exports even as domestic spending is slowing.
The murkier picture for the Canadian recovery is a far cry from the economy’s eye-popping expansion earlier this year, when output was getting boosts from government stimulus, companies were rebuilding depleted inventories, and consumers made big purchases that they put off during the recession. Growth for the first quarter of the year came in at a 5.8-per-cent annual pace, the fastest since late 1999, but slowed to a 2-per-cent clip in the April-through-June period as the housing market cooled following a mini-boom that started late last year as Canadians took advantage of record-low borrowing costs. Mr. Carney cut his Canadian forecast for both of the next two years, suggesting growth rates in the second half of 2010 and throughout 2011 will be well below what was achieved as the economy was vaulting out of the slump.
Raising Canadian rates further while the U.S. Federal Reserve is still nowhere near tightening could cause a rapid spike in the dollar, which would make Canadian products less attractive to foreign buyers. Plus, the U.S. central bank appears on the verge of taking fresh action to bolster the flagging recovery, likely through asset purchases that would depress the U.S. dollar and send investors who want higher yields flocking to currencies like the loonie.
“That’s a big factor why we expect them to stay on hold now, and even pause during the next leg of the tightening campaign, so they don’t run too far away from the Fed and drive the currency up,” said Robert Kavcic, an economist at BMO Nesbitt Burns, which predicts policy makers won’t raise rates again until May. In addition, Mr. Kavcic said, “there’s still a lot of uncertainties out there,” and the U.S. rebound is probably going to remain sluggish.
The Canadian economy will grow at a 3-per-cent pace this year, 2.3 per cent in 2011 and 2.6 per cent in 2012, the central bank said. That compares with Mr. Carney’s July forecast of 3.5 per cent growth for this year, 2.9 per cent in 2011 and 2.2 per cent in 2012.
Significantly, the bank revised its projection for when inflation will return to the Bank of Canada’s 2-per-cent target, as well as its forecast for when excess slack in the economy will have been chewed up. Both are now projected to occur at the end of 2012, instead of the beginning of that year.
While Mr. Carney pointed out that his decision to pause leaves considerable stimulus in place – in keeping with his recent warnings about the dangers of taking on debt that won’t be affordable when borrowing costs return to more normal levels – he reiterated that future hikes would need to be carefully considered. Private demand in the developed world should become “sufficiently entrenched” to sustain the global recovery, Mr. Carney predicted, but a combination of unemployment and belt-tightening by governments and households will limit the pace of growth. Also, expansion in the emerging markets that have powered the global bounce-back will slow as they take steps to keep their economies from overheating.
All of that is key because the central bank is counting on private-sector investment and exports to support growth as the impact of government stimulus fades and Canadians spend less.
Analysts expressed skepticism about how soon business investment or exports would be sufficient to fill those gaps.
“Given what’s happening in terms of foreign demand for Canadian goods, and the Canadian dollar, businesses may have great intentions but what actually turns out may be a bit less,” said David Madani, a Toronto-based economist with Capital Economics, referring to a survey of executives that the central bank released last week that showed companies plan to increase investment in new machinery and equipment.
