BOC Retains Tightening Bias Despite Downgrades To Its Canadian Growth And Inflation Forecasts
As widely expected, the Bank of Canada (BoC) left interest rates unchanged at 1.00%. The BoC stuck to its guns by leaving intact in its statement the phrase "some modest withdrawal of the present considerable stimulus may become appropriate". The Bank provided some clues about what will be in its Monetary Policy Report tomorrow by giving some information about its latest growth forecasts which, for the most part, seem to have been revised lower to reflect recent developments. The BoC acknowledged that global economic growth has deteriorated since April. The outlook for Europe has worsened and our central bank accordingly anticipates a "renewed contraction" (versus last April's view that there would be a slow recovery in the eurozone in H2 2012).
For Canada, the GDP growth forecast for 2012 was revised down substantially by three ticks to 2.1%, while 2013 was revised down one tick to 2.3%. The call for 2014 is for growth of 2.5%, three ticks above last April's call. All told, the economy is operating with more slack than it previously assumed and the BoC indeed acknowledged this by stating that the output gap is now expected to close in the second half of 2013 (versus first half of 2013 in April's MPR). With the larger negative output gap and much lower Brent oil prices than it assumed previously, the BoC now expects inflation to be milder than estimated back in April. Headline CPI is now expected to be "noticeably below" the 2% target over the next year.
Bottom line:
The tone of the statement wasn't as dovish as some would have expected, with the BoC keeping its tightening bias by reiterating that "some modest withdrawal of the present considerable stimulus may become appropriate." However, this is a conditional statement. Note that Governor Carney has been surprised in recent months which led him to upgrade his 2012 growth forecast by nearly 0.5% point in April only to withdraw it three months later (that is a big revision). We are now left with an economy that the BoC views will grow at best at potential over the next few quarters.
With inflation well below the BoC's target and the Federal government's recent decision to tighten mortgage rules, coupled with an output gap that remains open until H2 of 2013, there's clearly no urgency for tighter monetary policy in Canada. There's also little motivation for the BoC to go the other way unless forced by a recession ― the BoC is unlikely to cut rates as that would encourage debt accumulation, something which the Bank is concerned about. Still, we are disappointed that the Bank opted to keep the tightening bias in its statement as this will remain a focal point for financial markets and the Canadian dollar. All told, given the soft domestic economy and the growing uncertainty about global growth, we do not expect the BoC to resume rate hikes before Q4 of next year.
Here is the press release:
The Bank of Canada today announced that it is maintaining its target for the overnight rate at 1 per cent. The Bank Rate is correspondingly 1 1/4 per cent and the deposit rate is 3/4 per cent.