Bank of Canada Monetary Policy Report

The Bank of Canada released their Monetary Policy report this morning. It is a very interesting read as Canada remains one of the clear safe havens. The BoC discussed the risks facing the world economy and its direct impact on the Canadian economy going forward.

Global growth prospects have weakened since April. While the economic expansion in the United States continues at a gradual but somewhat slower pace, developments in Europe point to a renewed contraction. In China and other emerging economies, the deceleration in growth has been greater than anticipated, reflecting past policy tightening and weaker external demand. This slowdown in global activity has led to a sizable reduction
in commodity prices, although they remain elevated. The combination of increasing global excess capacity over the projection horizon and reduced commodity prices is expected to moderate global inflationary pressures. Global financial conditions have also deteriorated since April, with periods of considerable volatility. The Bank’s base-case projection assumes that the European crisis will continue to be contained, although this assumption is subject to downside risks.

While global headwinds are restraining Canadian economic activity, domestic factors are expected to support moderate growth in Canada. The Bank expects the economy to grow at a pace roughly in line with its produc- tion potential in the near term, before picking up through 2013. Consumption and business investment are expected to be the primary drivers of growth, reflecting very stimulative domestic financial conditions. However, their pace will be influenced by external headwinds, notably the effects of lower com- modity prices on Canadian incomes and wealth, as well as by record-high household debt. Housing activity is expected to slow from record levels. Government spending is not projected to contribute to growth in 2012 and to contribute only modestly thereafter, in line with plans to consolidate spending by federal and provincial governments. Canadian exports are projected to remain below their pre-recession peak until the beginning of 2014, reflecting the dynamics of foreign demand and ongoing competitive- ness challenges, including the persistent strength of the Canadian dollar.

The Bank projects that the economy will grow by 2.1 per cent in 2012,
2.3 per cent in 2013 and 2.5 per cent in 2014. The economy is expected to reach full capacity in the second half of 2013, thus operating with a small amount of slack for somewhat longer than previously anticipated.
Core inflation is forecast to remain around 2 per cent over the projection horizon as the economy operates near its production potential, growth in labour compensation stays moderate and inflation expectations remain well anchored. Given the recent drop in gasoline prices and with futures prices suggesting persistently lower oil prices, the Bank expects total CPI inflation to remain noticeably below the 2 per cent target over the coming year before returning to target around mid-2013.

The inflation outlook in Canada is subject to significant risks.
The three main upside risks to inflation in Canada relate to the possibility of higher global inflationary pressures, stronger Canadian exports and stronger momentum in Canadian household spending.
The three main downside risks to inflation in Canada relate to the European crisis, weaker global momentum and the possibility that growth in Canadian household spending could be weaker.

Overall, the Bank judges that the risks to the inflation outlook in Canada are roughly balanced over the projection period.
Reflecting all of these factors, on 17 July, the Bank decided to maintain the target for the overnight rate at 1 per cent. To the extent that the economic expansion continues and the current excess supply in the economy is grad- ually absorbed, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate, consistent with achieving the
2 per cent inflation target over the medium term. The timing and degree of any such withdrawal will be weighed carefully against domestic and global economic developments.

To read the full report visit the Bank of Canada’s site and you can download the PDF here

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Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He has been published by The MarketWatch, Reuters, the Wall Street Journal and The Globe and Mail, and he also appears regularly as a guest commentator on networks including Bloomberg and BNN. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza