Market Commentary
Bank of Canada downgrades economic forecast moderately
July 18, 2012 | Posted by: Francine Tracey
TD Economics
Data Release: Bank of Canada downgrades economic forecast moderately
The Bank of Canada’s July Monetary Policy Report (MPR) provides details on economic factors the Bank took into consideration in its decision to keep interest rates unchanged yesterday while it maintained its medium-term bias towards higher rates.
- The central bank revised its Canadian economic growth forecast to 2.1% this year and 2.3% in 2013, down slightly from 2.4% and 2.4% respectively in April MPR. The key contributing factor behind the downgrade was a weaker view of emerging market economies (EMEs), notably China, with inflation pressures easing. In Europe, another contraction is expected with higher-than-expected eurozone GDP growth in Q1 2012 likely to be followed by three-quarters of decline.
- In the U.S., the outlook to growth has also been lowered since April, reflecting household deleveraging and modest exports. In particular, the Bank is expecting that fiscal drag will subtract about 1.5 percentage points from total GDP growth in 2013 and 2014. However, it noted that the impact of the so-called “fiscal cliff” could be as high as 4 percentage points.
- The Bank’s new Canadian forecast matches ours for 2012 but is somewhat more optimistic than our recently revised forecast of 2.0% for 2013. The Bank expects consumer spending and (to a lesser degree) business fixed investment to be the main sources of growth this year and next. Housing investment is projected to slow, in part due to what the Bank terms as “prudent and timely” changes to mortgage rules by Finance Canada and OSFI.
- Core inflation is expected to remain around the 2% target over the forecast horizon, and the Bank’s view is that the headline rate will remain below 2% for the rest of the year before returning to the target in mid-2013. Lower demand from emerging economies has played a significant role in the recent drop of commodity prices but the Bank expects those prices to remain elevated over the medium term as the global economy recovers.
Key Implications
There is little in today’s Report that will rattle markets.
- Today’s MPR brings the Bank of Canada’s outlook in line with that of the private sector. Even then, headline numbers were published in yesterday’s statement accompanying the interest rate announcement.
- Today’s MPR reinforces our expectation that a gradual increase of interest rates is in the cards, starting in March 2013 and totalling 1% over the following 12 months. The increase is justified by the Bank of Canada’s perception that the Canadian economy will reach full capacity in the second half of 2013, but also by persistently high household debt levels, which represent a sizeable risk to the outlook. Despite the widespread belief that the next move by the Bank will be up (making Canada the first major economy to withdraw monetary stimulus), markets are still pricing in modest interest rate cuts.
Source Jacques Marcil, Senior Economist