April 2016

A cautiously optimistic central bank

April 15, 2016

As widely expected, the Bank of Canada left the overnight rate unchanged at 0.50% today. While the central bank raised Canada’s growth forecast significantly for this year, it was still concerned about the global economy as evidenced by a downgrade to its world growth forecasts to just 3% this year and to 3.4% in 2017 ─ upgrades to China were more than offset by downgrades to the US, the euro area and Japan. The central bank expects the US to regain momentum “but with a lower profile and a composition that is less favourable for Canadian exports”.

While the central bank raised its 2016 growth forecast for Canada to incorporate the government’s fiscal stimulus, it was careful not to sound too positive. The central bank doesn’t want to fuel a Canadian dollar that is already at a multi-month high versus the USD. The BoC expects provinces to offset some of the federal stimulus. Moreover, the central bank highlighted risks to the global economy, but more importantly expects a lower growth profile in the US with “a composition that is less favourable for Canadian exports”, something that causes trade to be a net drag on the Canadian economy next year. Even then, the output gap is now slated to close by mid-2017, sooner than what was expected back in January. The earlier elimination of slack was also helped by a lower potential, the latter largely related to the collapse in investment. All told, the central bank tried to send the message that caution is warranted despite a more upbeat near-term outlook. Still, the MPR should put to rest speculation of more rate cuts in Canada. How about rate hikes? The significant downward revision to potential output growth argues for an equilibrium interest rate that is lower than historic norms. In other words, when comes the time to hike (i.e. after 2016), don’t expect an aggressive tightening cycle.

Krishen Rangasamy / PA Pinsonnault