The Bank of Canada is downgrading its economic outlook again as the country continues to grapple with the “complex” aftershocks of lower prices for oil and other commodities.
As expected, the central bank kept its key overnight lending rate unchanged at 0.5 per cent Wednesday, following two surprise rate cuts earlier this year.
After flirting with a recession early this year, the Canadian economy will grow just 2 per cent in 2016 and 2.5 per cent in 2017, the bank said in latest monetary policy report, also released Wednesday. That’s down from previous forecasts of 2.3 per cent and 2.6 per cent.
Lower oil prices are continuing to sap business investment and put a dent in the value of Canadian exports, overwhelming improvements elsewhere in the economy. And the bank warned that the two-track economy will persist longer than expected, in spite of the positive effects of earlier interest rate relief and the cheaper Canadian dollar.
“Lower prices for oil and other commodities since the summer have further lowered Canada’s terms of trade and are dampening business investment and exports in the resource sector,” the bank said in its statement.
“The complex adjustments to the decline in Canada’s terms of trade will continue to play out over the projection horizon.”
The Canadian dollar was trading at 76.55 cents (U.S.) following the release of the report, down from Tuesday’s close of 77.03 cents (U.S.)
The bank’s more sober outlook could delay eventual interest rate hikes in Canada, just as the U.S. Federal Reserve appears poised to start raising U.S. rates. This could put push the Canadian dollar, now trading at under 77 cents (U.S.), even lower as investors seek higher returns in the United States.
Private-sector economists have suggested that Canada’s economy could gain a lift next year and beyond if the newly elected Liberal government makes good on its promise to boost infrastructure spending and cut some taxes. That could take some pressure off the bank to cut rates again if the new government moves quickly to get money out the door.
In July, the bank lowered its forecast for GDP growth this year to 1.1 per cent from 2 per cent. The bank hasn’t changed its view that the economy will grow roughly 2 per cent in the second half, after contracting in the first six months.
Part of the problem is China, whose “transition to a slower growth path” is depressing commodity prices.
More worryingly, the Bank of Canada warned that the potential growth rate of the economy may be weaker than expected because of “capacity destruction,” some of which may be never come back.
“Permanent reductions in capacity, including through firm exit, result in the loss of capacity for future production,” the bank said in its monetary policy report. The result is that potential growth of the economy is “likely to be in the lower part . . . of estimates” this year and next.
The price of crude had started to recover in recent months, but has since retreated again, hovering at around $45 a barrel.
The bank pointed out that Canadian consumers and businesses are not getting the full benefit of cheaper crude because gasoline prices haven’t fallen as rapidly as oil prices. The two sets of prices typically move in sync, but that hasn’t happened due to higher demand and “insufficient” refining capacity in North America, due to refinery outages in the U.S, according to the bank.
Business investment is likely to decline a further 0.2 per cent in 2016, paced by further declines in the oil patch. It had previously expected business investment to rebound after a nearly full percentage-point drop this year.
The bank also acknowledged that economic “slack” has increased this year, delaying a return to full capacity – an indicator of when the central bank may need to push up interest rates. It now estimates the economy won’t reach full capacity until “around mid-2017.”
Over the past year, the bank has steadily pushed back its full capacity target – from early 2016. In July, the bank had predicted the economy would reach full capacity in the “first half” of 2017.
Nonetheless, the Bank of Canada says the rebound in the non-energy side of the economy is now “more evident.”
On inflation, the bank said the “core” rate remains close to 2 per cent. The cheaper Canadian dollar is pushing up the price of imported goods, including clothing, appliances, books and food. The bank said these “temporary” effects are being offset by the weaker domestic economic.
The bank said underlying “trend” inflation is now running at 1.5-1.7 per cent.