Canada's economy has hit the ground running in 2017. Now the Bank of Canada has little choice other than to play catch-up.
Friday's real gross-domestic-product report showed that the economy expanded 0.6 per cent month over month in January, matching the strongest single-month growth since mid-2011. The gains were spread all over the economy: Manufacturing, construction, retail and wholesale trade, energy and mining all showed impressive growth.
January did benefit from unseasonably warm weather in much of the country, which may have given a lift to typical economic activity in the month. But January was no one-off. Economic indicators have been beating expectations for months now, painting an increasingly vivid picture of an economy that has emerged in earnest from the ashes of the oil shock.
Over the past three months, Canadian real GDP has grown at a torrid annualized rate of nearly 6 per cent. In the past six months, the pace has been a brisk 4 per cent. Bank of Montreal chief economist Doug Porter noted that the economy has not enjoyed a half-year run that strong since the early days of the recovery from the Great Recession, in 2010.
These numbers will make the next week or so very interesting around the Bank of Canada, as it prepares to update its economic outlook in its quarterly monetary policy review (MPR), to be released on April 12. The run of strong data, extended and amplified by January's result, seriously challenges the bank's caution, bordering on skepticism, about the economy's recent strength.
Just a few days ago, Bank of Canada Governor Stephen Poloz was remarkably circumspect about the economic data, saying only that there are "a lot of moving parts" and emphasizing the "important potential downside risks" to the economic outlook.
"It would be odd to forget about all those downside risks just because a couple of data points came in a little bit better than expected," he said.
"We would respond that it's a lot more than 'a couple,' and it's a lot more than a 'little bit better,'" Mr. Porter countered in a research note. "There is no denying that there are plenty of risks to the forecast, but clearly some of those risks are squarely to the upside at this point."
A belief remains in some quarters that Mr. Poloz's pessimistic tilt may reflect his desire to keep a lid on the Canadian dollar because a weaker currency is more favourable for Canadian exports. The Governor has always bristled at the suggestion he has any desire to manage the level of the currency, but there's little question that having the loonie lower for longer would help lead the economic recovery down the path Mr. Poloz has long envisioned – where growing demand for exports prompts Canadian producers to spend on extending capacity, thus expanding the economy's growth potential.
In recent months, the central bank has emphasized the differences between the state of Canada's recovery and the much more advanced U.S. one, a message designed to cool rising financial-market expectations that the bank would follow the U.S. Federal Reserve's lead and start raising interest rates sooner rather than later in reaction to the accelerating economy. That market perception has fuelled gains in the Canadian dollar and market interest rates, which create headwinds for the recovery.
Nevertheless, the Bank of Canada will have to acknowledge that the economy is growing meaningfully faster than it has projected.
In light of the January GDP report, many Bay Street economists are talking about growth in the range of 3.5 per cent to 4 per cent (annualized) for the first quarter; the Bank of Canada's most recent quarterly forecast, issued in January, called for 2.5 per cent. On Friday, Bank of Montreal's Mr. Porter raised his full-year growth forecast to 2.5 per cent, nearly a half percentage point above the Bank of Canada's projection.
That strongly suggests Canada's output gap – the unused capacity in the economy – is closing faster than the Bank of Canada thought. The central bank has been saying that it expects the output gap to close around the middle of next year, which would be the trigger for it to start raising interest rates. But the higher growth path that has emerged could move that timing forward by at least a quarter.
The bank will be compelled to adjust its thinking accordingly when it releases its new outlook. Still, don't expect a total about-face from Mr. Poloz and his colleagues. The bank will continue to temper the empirical evidence of an accelerating recovery with the list of downside risks that could still derail this increasingly positive outlook. Those include depressed business investment, slow wage growth, an overheated Toronto housing market – and the big one, the uncertainties surrounding the protectionist trade agenda being pursued by U.S. President Donald Trump.
"The Bank of Canada will lean on those political uncertainties, to avoid a sharper turn towards hawkishness in its April MPR," Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, said in a research note. "But the timetable for a rate hike may be moving up to earlier in 2018 rather than later."
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