Stephen Poloz's "serial disappointment" in the global economy suggests that a Bank of Canada interest rate hike could still be as much as two years away.
The central bank governor cautioned Wednesday that despite Canada's recent surprise surge in consumer prices, the stubborn lack of traction in global growth is delaying Canada's recovery and will constrain inflation over the longer run.
His comments came after the central bank issued new economic forecasts that raised inflation projections for this year, but cut economic growth forecasts and projected the economy won't return to full capacity until mid-2016, months later than previously anticipated.
In a press conference following the release of the central bank's quarterly Monetary Policy Report, Mr. Poloz acknowledged that the recent surprise jump in Canada's inflation rate, to above the Bank of Canada's 2-per-cent policy target, has moved the economy away from the risks of very low inflation that it had feared a few months ago.
Nevertheless, he hammered home the point that stubbornly slower-than-expected economic growth, both at home and in export markets, has created a longer-lasting risk of lower-than-target inflation.
"The serial disappointment with global economic performance for the past several years … means that we remain preoccupied with downside risks to economic activity and the fundamental drivers of inflation," he said.
The central bank raised its consumer price index inflation estimates to 2.1 per cent for the just-ended second quarter and 2 per cent for the third quarter, from 1.6 per cent and 1.8 per cent, respectively, in its previous MPR in April.
It raised estimates for its closely watched "core" inflation measure – which excludes some of the most volatile components of CPI, and is considered a better gauge of the broader inflationary trend – to 1.6 per cent in the second quarter and 1.7 per cent in the third quarter, from 1.2 per cent and 1.4 per cent, respectively, in the April report.
But it also cut its gross domestic product growth projections for the rest of the year, reflecting Canada's weak growth in the first part of this year as well as a slower global pace. As a result, the central bank predicted the economy won't return to full capacity until mid-2016. back from its previous forecast of early 2016. And it doesn't expect core inflation to return sustainably to 2 per cent – the inflation target the bank relies on as its guide for adjusting interest rates – until the third quarter of 2016, rather than the 2016 first quarter as previously forecast.
"For the inflation target to be achieved on a sustained basis in 2016, the economy must reach and remain at full capacity," the central bank said. It reiterated that the closing of this output gap continues to hinge "critically" on improved exports and business investment.
The central bank left its key policy interest rate unchanged at 1 per cent in its regularly scheduled policy statement, as had been expected. It removed from the statement its previous assertion that there were still "important" risks of disinflation – which had been widely viewed as a signal that the bank might still consider lowering its policy rate further. However, it stressed that its policy position is "neutral," implying it is leaning neither toward rate increases nor cuts.
The central bank still believes the recent surge in inflation was due to "temporary effects," mainly from higher energy prices and the decline over the past year of the Canadian dollar. Still, it noted that other more lasting inflationary pressures are on the horizon.
"Over the next two years, inflation is projected to fluctuate around 2 per cent as these temporary effects ease and the downward pressure on inflation from economic slack and heightened retail competition gradually dissipates," the statement said.
The central bank cut its real GDP forecasts to a 2.3-per-cent annualized pace in the third quarter and 2.4 per cent in the fourth quarter, down from 2.6 per cent and 2.5 per cent, respectively, in the April projections. It sees GDP growth of 2.1 per cent for all of 2014, down from 2.3 per cent previously, although its 2015 growth projection remains at 2.4 per cent.
"The most important thing has been the failure for [non-energy] exports to recover," Mr. Poloz said of the economy's persistent output gap. A year ago, in his first MPR as head of the Bank of Canada, the central bank had predicted that the gap would be closed by the middle of 2015 – a full year earlier than the newest view.
He said that while the ingredients appear to be in place for an export recovery, continued uncertainty among businesses worldwide is constraining the investment needed to accelerate export demand. He added that while about half of Canada's export sector has recovered to more "normal" levels, many major sectors, most notably autos, are still "languishing."