The Bank of Canada is leaving its key interest rate unchanged, betting that a burst of federal infrastructure spending and a global recovery will lift the Canadian economy out of its funk.
Governor Stephen Poloz and his central bank colleagues opted Wednesday not to cut the bank's overnight rate, now set at 0.5 per cent, in what analysts had predicted would be a very close call.
Looking beyond the ongoing stock market correction and a continued slide in the price of oil, the bank insisted 2016 will be a turnaround year for the economy.
"While risks to the world outlook remain and have been reflected in sharp price movements in a range of asset classes, global growth is expected to trend upwards in 2016," the bank said in a surprisingly upbeat statement.
The bank insisted Canada's wrenching pivot from a resource-driven economy to one powered by other activities is "under way" and that the job market remains "resilient" outside the resource sector.
But the bank acknowledged that the economic environment remains "highly uncertain." And it once again slashed its growth forecast for 2016 – to 1.4 per cent from 2 per cent – and warned that more turmoil is in store for the oil patch.
By not cutting rates, Mr. Poloz may also want to avoid triggering an even sharper dive in the Canadian dollar – one of the world's weakest currencies in recent months. Lower Canadian interest rates typically depress the currency as investors seek better returns elsewhere, including the U.S., where the Federal Reserve has begun to hike its own rates.
Most analysts say a rate cut later this year remains a possibility. CIBC World Markets economist Nick Exarhos said Mr. Poloz appears "willing to wait and see what the Finance Minister [Bill Morneau] provides as a bolster to the economy before pulling the trigger on any more monetary easing.
The decision to not cut now suggests the central bank was worried about knocking the dollar down further and causing already debt-laded Canadians to borrow more, Bank of Montreal chief economist Douglas Porter said.
The cheaper dollar has also caused angst among many Canadians who now face sharply higher prices for groceries and other imported goods, as well as winter getaways to the U.S. Even exporters, who stand to benefit most from a low dollar, had warned that a further drop would not be helpful.
The dollar fell below the psychological threshold of 70 cents (U.S.) this week, dragged lower by the dropping price of oil and anticipation of a possible Bank of Canada rate cut.
Speaking to reporters in Ottawa, Mr. Poloz acknowledged that the bank's decision not cut rates again was influenced by fears that a more pronounced drop in the dollar could spur unwanted inflation plus the expected fiscal stimulus coming from the federal government.
"The likelihood of further fiscal stimulus was an important consideration," he said.
At the same time, "another rapid depreciation" in the Canadian dollar could send inflation sharply higher as imported goods become pricier, he said.
"We need to be patient," Mr. Poloz added.
The bank pointed out that its latest forecast does not factor in the "positive impact of fiscal measures expected in the next federal budget." The new Liberal government has promised to run deficits and boost infrastructure spending by roughly $5-billion a year, but is under pressure to do even more. The bank said the size and timing of this stimulus won't be known until the federal budget, expected in March.
Mr. Poloz acknowledged that Canada's economy suffered a "setback" in the final three months of last year, but he dismissed this as a largely temporary stall.
Some economists say the economy may even have shrunk in the fourth quarter – in what would be a third quarter of negative GDP in 2015.
Instead, the bank estimates that gross domestic product grew a slim 0.3 per cent in the fourth quarter and is poised to gather momentum as the year progresses. The bank blamed the stall on weaker-than-expected U.S. factory production, lower business investment at home and various temporary factors, including a strike by Quebec public sector workers.
Growth is expected to rebound in 2017 to 2.4 per cent, or roughly in line with the bank's previous forecast in October.
The bank has also pushed back, once again, its estimate of when the Canadian economy will return to full capacity – to "around the end of 2017" from mid-2017. This suggests the Bank of Canada could keep interest rates at today's low level for up to another two years, even as the Federal Reserve ratchets up U.S. rates.
The bank expects that the depressed price of oil will recover – at least in the medium term. The price of crude has plummeted to near $30 a barrel from more than $100 in the past two years.
"The risks to oil prices are tilted to the upside," the bank said in its monetary policy report. "The significant reductions in oil investment since late 2014 could leave future demand increases unmet, putting upward pressure on prices and drawing investment back into the sector."
The bank's forecast, however, assumes that oil prices will stay "near their recent levels."
The bank is also warning that conditions could still get much worse in the oil patch, where job losses and production cuts have already plunged the province of Alberta into recession. "Low oil prices . . . will require more fundamental changes to operations and could be more profound than the already difficult adjustments made in 2015," the bank said in its monetary policy report.
The bank pointed out, for example, that even at prices of $40-$50 a barrel (for West Texas Intermediate crude) many industry executives say the "current composition of the industry is unsustainable."
Many oil sands operations are "approaching break-even prices on a cash flow basis," which could trigger further cuts to production and investment it said.
The bank says investments by energy companies will fall 25 per cent this year, or even more sharply than the 20 per cent drop it projected just three months ago. Investment plunged 40 per cent last year.