Bank of Canada's Monetary Policy Report indicates minimal growth in the Canadian economy in the first half of 2008

April 24, 2008

 

The Bank of Canada's announcement on Tuesday of the 50-basis point cut in the overnight rate indicated that the central bank had reduced its outlook for growth this year and next. The release this morning of the Monetary Policy Report provided further details about this revised growth profile for the economy. The central bank is now projecting GDP growth this year of 1.4% rising to 2.4% in 2009 and 3.3% in 2010. This compares to projections released in the January MPR Update of 1.8% and 2.8% for 2008 and 2009, respectively. RBC's forecast is for growth of 1.6% and 2.3% over the same period. The Bank of Canada is providing a 2010 growth rate for the first time. 

 

The Bank continues to point to buoyant domestic economy supported by strong employment gains and rising terms of trade that have been keeping income growth strong. The Bank is projecting that final domestic demand will contribute 3.9 percentage points and 3.2 pp to overall GDP growth this year and next respectively. This compares to contributions of 3.3 pp and 3.5 pp percentage points projected in January over the same period. The upward revision for 2008 largely reflects stronger consumer spending. Business investment is marginally weaker in both years, largely a function of the tightening in credit conditions. 

 

The main area of concern for the Bank continues to be net exports. Today's MPR indicates that this area of the economy will subtract -2.4 pp and -0.8 pp from growth this year and next, respectively. In January the subtraction was a smaller -1.4 pp and -0.7 pp for 2008 and 2009 over the same period. The revision reflects greater weakness in the U.S. economy. 

 

The Bank is assuming that the Canadian economy skirts a recession though growth in the second quarter plummets to a minimal 0.3% after rising only 1.0% in Q1. This weak growth reflects the fact that the Bank of Canada is concurring with earlier statements by the Fed that U.S. GDP is likely "to decline marginally in the first half of 2008." An expected rebound in the US economy helps Canadian growth to revive over the second half of this year averaging 1.8% over this period. 

 

The US annual growth numbers have been revised down significantly because of this greater near-term weakness. In January the Bank of Canada was assuming that that economy would expand by 1.5% and 2.5% in 2008 and 2009, respectively. They alluded to this revision in their statement on Tuesday and provided the actual numbers today with the growth rates dropping to 1.0% and 1.7% for this year and next, respectively. This downward revision was the main factor contributing to global growth being cut to 3.7% and 3.5% over the same period from the 4.1% and 3.9% implied in January. 

 

The downward revision to growth results in the economy operating in excess supply longer than previously assumed. Today's MPR indicated that the economy will not move back into balance until around mid-2010 rather than early 2010 as had been projected in January. Related to this, the central bank's inflation outlook has been lowered as well. Slack in the system will result in both core and overall inflation not returning to the Bank's mid-point target of 2% until 2010. In January the central bank had talked about inflation returning to target by the end of 2009.

 

The downward revisions to both growth and inflation leave open the strong possibility that further interest rate cuts are in the offing. The MPR clearly states, as did Tuesday's statement, that "some further monetary stimulus will likely be required." However, as in the statement on Tuesday, the central bank seem less inclined to suggest that further cuts are imminent but are rather dependant on greater downside risks to growth emerging from either weakening economic data or a deterioration in financial markets. Our forecast assumes that the Bank of Canada will undertake one further 25-basis point cut in the overnight rate to ensure that growth remains positive near-term and that the pace of activity starts to trend higher over the second half of this year.

 

Bank of Canada cuts overnight rate by 50 basis points

April 22, 2008

 

The Bank of Canada cut the overnight rate by 50 basis points to 3% citing the "sharp slowdown in the U.S. economy and ongoing dislocations in global financial markets" (with attendant tightening in credit conditions) and indications that "growth in the Canadian economy has also moderated."

While the statement still points to further easing the language is less definitive than in the March statement, suggesting that the Bank is shifting to a less aggressive stance. After a modest downgrade to the inflation forecasts, the Bank now views the risks as being balanced.    

As usual, the Bank previewed the changes to their economic forecasts that will be presented in the Monetary Policy Report on Thursday. While policymakers still characterize Canada's domestic economy as buoyant, supported by the improved terms of trade and strong labour market, worries about the impact of the tightening in credit conditions and the flagging U.S. economy on the outlook for exports resulted in downgrades to Canada's 2008 and 2009 GDP forecasts. The Bank downgraded their forecast for 2008 growth to 1.4% from 1.8% in January with 2009 GDP growth forecast at 2.4%, below January's 2.8% projection. The Bank expects the economy to reaccelerate in 2010 with GDP growth projected at 3.3%. 

We expect that the detailed table contained in Thursday's Report will show the Bank increased the anticipated drag from net exports on 2008 GDP growth from the 1.4 percentage points forecast in the January Update.  This would be in line with the statement that "the Bank is now projecting a deeper and more protracted slowdown in the US economy" which will continue to temper demand for Canadian exports. The Bank also expects the tightening in credit conditions to "moderate business investment and consumer spending." 

Inflation has been tracking the Bank's forecast, with the all-items averaging 1.8% in the first quarter (versus the Bank's forecast of 1.7%) and the CPIX averaging 1.4%, bang on expectations. The prospect of weaker growth "should keep downward pressure on inflation through 2009. Both core and total inflation are projected to move up to 2% in 2010 as the economy moves back into balance." In their January statement, the Bank expected both the core and all items rates to move up to 2% by the end of 2009 with the March statement indicating the risks to the outlook were to the downside. This time, the Bank characterized the risks to the inflation outlook at being more balanced.

While the statement reiterated that "some further monetary stimulus will likely be required to achieve the inflation target" the Bank omitted "in the near term" in today's statement. This omission indicates that policymakers will be gauging the effects of the recent rate cuts on the economic outlook and, although the statement still leaves the door open to further downward adjustments in the policy rate, the degree of future easing is likely to be limited. We look for the Bank to lower the overnight rate in June to 2.75% and then look for policymakers to shift to the sidelines for the remainder of the year.

 

Bank of Canada's Business Outlook Survey

April 14, 2008

The Bank of Canada's spring 2008 Business Outlook Survey showed that a number of indicators eased from their level in the winter survey.  The survey was continued between February 22nd and March 20th 2008.

The balance of opinion, which is the percentage of firms expecting faster growth minus the percentage of firms expecting slower growth, on future sales growth turned slightly negative compared to a flat reading reported in the fourth-quarter survey.  This was the first negative reading since the first quarter of 2001.  The survey indicated that businesses negatively affected by the U.S. situation were expecting tough times, while those not as exposed were more optimistic.

The balance of opinion on M&E investment dropped to close to zero (1.96), indicating that firms expected the level of investment to be about the same as compared to the prior 12 months.  This compares to a balance of opinion reading of 8.00 reported in the winter survey.  The moderation was partly due to concerns about the outlook, though the most cited reason was significant investment spending last year. However, hiring intentions remained firm as 45% of firms reported intending to increase their hiring, versus 42% in the winter survey.  Meantime, the percentage of firms planning to reduce their hiring dropped slightly to 11.8% from 12.0%.  This could suggest continued solid employment gains going forward.  The balance of opinion on credit conditions was strongly positive for the third consecutive quarter, indicating that the terms and conditions for obtaining financing continued to tighten. 

The survey showed that pressures on production capacity eased as the percentage of firms reporting that they would have a significant difficultly meeting unexpected demand - viewed as an output gap proxy by the Bank of Canada - dropped from its all-time high winter reading to a figure more in-line with the average for the survey.  This reflected fewer pressures among firms in Central and Eastern Canada.  Firms in the West continued to account for most of the reported number of firms expecting significant difficulty meeting an increase in demand.

On input price inflation, firms expected an acceleration in the growth of input price pressures over the next 12 months.  Record high oil prices along with recent strength in food prices as well as rising import prices from China were all cited as factors leading firms to expect higher input prices.  Firms expected their own output prices to accelerate over the next 12 months.  The balance of opinion on output prices was at its highest level since the third quarter of 2005.  However, consumer price inflation expectations were largely in-line with the prior survey.

The increased pessimism about sales is unsurprising, given the heightened discussion of a possible US recession that was evident over the survey period.  It is to some degree troubling that firms were expecting their own output prices to increase at a faster pace over the next 12 months and some firms expected to pass-through higher input prices.  However, the Bank of Canada has proven that they want to be proactive in the countering downside risks to growth stemming from the U.S.  Given that the deterioration in sales and, probably to some extent, investment prospects were tied to concerns about the U.S. outlook, the survey supports the case for rates to head lower.  Our forecast calls for the overnight rate to drop to 2.75% by the end of the second quarter.