Canada's recession is over, and the country is beginning what will be a long reconstruction of the wealth destroyed by the financial crisis, the Bank of Canada said Thursday.
Gross domestic product will expand at an annual rate of 1.3 per cent this quarter, compared with an earlier forecast for a contraction of 1 per cent between July and September, the central bank said in its latest monetary policy report.
The dramatic shift is the result of stronger financial conditions, surprisingly high consumer and business confidence and a first-half contraction that was less severe than the economic catastrophe the central bank was bracing for when it last published its views on the economy in April.
If the bank's new forecast proves correct, Canada's first recession since the early 1990s lasted three quarters, making it one of the shortest downturns on record.
Canada's economy was operating about 3.5 per cent below its production capacity, a hole that will take well into 2011 to fill, the central bank said. The automotive and forestry industries are restructuring, business investment is weak and unemployment continues to rise.
All that will make the recovery fragile, and explains why the central bank recommitted Tuesday to keep the benchmark lending rate at a record low of 0.25 per cent until the middle of next year.
"We believe the economy will grow this quarter," Bank of Canada Governor Mark Carney said at a news conference. "This isn't a foregone conclusion. Policy is important. Monetary policy is important. Fiscal policy is important, and the caveat, effective implementation of policy outside our borders, remains important."
The bank's revisions are based on a domestic economy that has weathered the global recession better than policy makers expected and confidence that the rebounds in the United States and China are about to give a lift to exporters and commodity prices.
In April, the central bank predicted the economy would collapse by 7.3 per cent in the first quarter, a reading that instead came in as a 5.4 per cent contraction. The former would have been the worst on record; the later is the biggest decline since the recession of the early 1990s.
"With the reiteration of the conditional commitment to keep rates unchanged, it seems like the compass continues to point to a slow, but eventual recovery," said TD senior economics strategist Charmaine Buskas.
The central bank left its second-quarter outlook unchanged, predicting GDP shrank 3.5 per cent between April and June.
Consumer spending likely increased in the period, bringing forward purchases that policy makers originally assumed would occur later this year or even next, the report said. Household credit has remained surprisingly high, reflecting the central bank's efforts to lower borrowing costs to encourage purchases of houses and other big ticket items.
Over the months ahead, the Bank of Canada is counting on exporters to take over from consumers.
The U.S. economy is "at its trough," and Canadian exporters will benefit disproportionately from the rebound because of their tight trade links with the world's largest economy, the Bank of Canada said. China's growth also is remarkably strong, which will provide a boost to commodity prices, the report said.
The biggest threat to the bank's outlook is the dollar, which has surged more than 5 per cent this month, jumping to more than 90 cents (U.S.).
Policy makers worry about persistent strength in the currency because it makes Canadian exports less competitive abroad. The central bank's forecast for economic growth of 3 per cent in 2010 and 3.5 per cent in 2011 is based on an assumption that the loonie's value will average 87 cents over that period.
"A stronger and more volatile Canadian dollar could act as a significant drag on growth and put additional downward pressure on inflation," the report said.
The central bank is mandated by law to keep inflation advancing at a pace of about 2 per cent a year. The bank's inflation outlook remains largely unchanged from April. Policy makers predict the consumer price index declined in the second quarter, will drop 0.7 per cent this quarter and eventually reach 2 per cent in the second quarter of 2011.
Financial conditions also could take longer to return to normal, since unexpected losses at financial institutions could trigger another crisis of confidence in credit markets, or bond traders could demand higher yields because of concern over rising budget deficits, the report said.
"Fragility in the global economy persists," the central bank said. "Financial deleveraging by banks, households and firms is continuing, mirrored by ongoing adjustments on the real side of the economy."
In Toronto, Finance Minister Jim Flaherty agreed the economy is moving into a phase of "modest" growth.
"Consumer confidence is relatively strong and growing, we are seeing good home sales numbers (and) some improvement in retail sales," Mr. Flaherty said.