Economy—Bank of Canada on Interest Rates, Revised Economic Growth Forecast and Effect on Finance Minister Morneau’s Budget Forecast
Bank of Canada, Interest Rates and Growth
To the surprise of no one, the Bank of Canada announced yesterday morning that the overnight rate target would remain at 1.75%. This was basically forecast after Governor Poloz’s speech to the Baffin Regional Chamber of Commerce a couple of weeks ago. Economic growth has been slower than originally thought or predicted so rates stay low to provide stimulus.
Also inflation seems to be under control o there is no need to hike rates to keep it within the allowable band of between 1% and 3%.
But as the morning went on yesterday, it became evident that what was being announced by maintaining rates where they are and the growth forecast as set out in the Banks’s quarterly Monetary Policy Report (MPR), was that the present fiscal situation in Canada was a little more complex than originally anticipated.
Also the U.S. Federal Reserve which meets next week may want to review the forecast for U.S. economic growth, as it is not close to where President Trump believes it will be; but more on that later.
The text which accompanied the rate announcement began with an acknowledgment that global economic growth has slowed more than forecast in January’s MPR. This became a major theme throughout the documents produced by the Bank and the media availability by Governor Poloz and Senior Deputy Governor Carolyn Wilkins held following the rate announcement.
Getting back to the slowdown in global growth, this was attributed to trade conflicts causing uncertainty which served to undermine business activity and how business views the future. This slowdown was ubiquitous across many countries. Central banks have reacted by slowing the march back to rate normalization. Global economic activity is expected to pick up in 2019 but will come in lower than the Bank’s January forecast; now global growth is pegged at 3.2%.
Canada’s growth is expected to be lower than forecast in January’s MPR as business investments are down as well as energy exports. One of the main reasons for the downward growth revision from January is that investment and exports outside the energy sector were negatively affected by trade uncertainty and the global slowdown. The Bank of Canada anticipated the slowdown in the energy sector, but not outside the sector.
There was also weaker than anticipated housing and consumer consumption numbers also contributing to slower than forecast growth.
Looking ahead to the rest of 2019, the Bank expects; 1) housing activity to pick up, 2) improved global financial conditions, 3) increased consumption underpinned by strong wage growth, and 4) investment to expand as well as exports based on increased global demand.
However the forecast for growth has been dramatically revised. The January forecast had growth at 1.7% in 2019. Now growth is forecast to be 1.2% in 2019 and around 2.1% in 2020 and 2% in 2021. Core inflation will remain close to 2% but may dip in Q3 and return to 2% for rest of 2019 and through 2020 and 2021.
The Bank justifying its decision to leave rates where they are stated “an accommodative interest rate continues to be warranted.” The Bank will evaluate the appropriate degree of accommodation as new data arrives. The Bank will continue to review household spending capacity, oil markets and global trade policies in order to detrmine if the forces that inhibit growth are dissipating.
Commenting on the rate announcement Kevin Carmichael wrote that the economy has stalled over the last six months. He believes that rates will be on hold until at least sometime next year as “the pause in December on raising rates in now a hiatus.”
He argues that the Bank failed to see the downturn coming and growth in Q2, this year will come in at 1.3%. He noted that inflation is no longer an issue so the Bank will now focus on generating some.
Monetary Policy Report
The following information from the report seemed most relevant: U.S. growth is forecast to slow to a more sustainable pace with it forecast to come in at 2.25% in 2019 but then down to 1.75 in 2020 and 2021.
The Canadian economy was affected by trade tensions, leading to an elevated degree of uncertainty. The economy now has a modest degree of excess capacity because of the slowdown in growth. Household spending is projected to rise and business investment outside of oil and gas is to rebound. Oil is still stranded by transportation constraints and there is an expectation that investment will be reduced. Non-energy exports are predicted to expand moderately. Inflation will hover around or close to 2%
Governor Poloz began by saying that in 2017 and 2018, Canada’s economy was operating at full capacity and the slowdown described today will be temporary, but the economy slowed more than expected. Trade conflicts were blamed for slowing business decisions and escalating trade conflicts made it worse.
In Canada, Poloz explained that 1) the oil sector was under considerable stress, 2) there is uncertainty about future trade policies which has yet to be resolved, 3) the housing market is being monitored to see how changes in policy play out and 4) the Bank will monitor several business announcements that will add to growth. Poloz pointed out that the January MPR was based on projected spending by the Wynne government and that has been considerable reduced by the Ford government which has contributed to a downturn in growth.
Poloz also noted that the rate announcement has removed references about returning rates to a neutral range. The Bank will continue to monitor the data.
In the Q and A session Poloz as asked about missing the drop off in global growth in the Bank’s forecasting. A long discussion about how forecasting is done and it is an inexact science ensued. Once there is a downturn this is monitored until the economy gets back to normal.
Poloz was asked about the possibility of a rate cut. He answered that the economy was already into recovery and the data to show that will follow. The Bank has removed the reference about returning to neutral rates.
Rates will be taking a “detour” as Poloz explained, while growth returns. He said that there was no rush to get back into the saddle” as rates are appropriate for this outlook. However if something negative comes along that could change.
Poloz was asked about the effect of the carbon tax on inflation. He responded that it would add.1% to inflation. Poloz seemed rather unconcerned about this tax raising the cost of food and energy and how that would affect inflation. His lack of concern seemed connected to the rebates from government.
Going back to Carmichael, he wrote “the central bank now predicts GDP will expand 1.2% in 2019, compared with the January estimate of 1.7%. It would be the weakest growth since 2015-16 when the country barely avoided a recession.” Commenting further on the revision from the January MPR he stated “the miss by the Bank could undermine confidence in the Bank’s prediction that the soft patch is essentially over.”
In addition, does this revision downwards by the Bank mean that the numbers contained in Finance Minister Morneau’s budget need to be revised as well? Remember how adamant Morneau was after delivering the budget that those concerned about a possible recession “would be incorrect” and that the budget’s growth forecast of 1.8% in 2019 was solid.
Yesterday’s announcement is good news for those with variable rate mortgages and those trying to enter the housing market. There will probably be no increase in the prime rate for six months or longer.
Prime Minister Trudeau would probably prefer the economy of 2017 and 2018 going into the fall election, but slow growth and downward revisions to growth estimates are now what the Bank predicts for 2019.
--today, Senate Energy Committee studying Bill C-69 is in Saint John NB and tomorrow in Quebec City
--April 27-28, Prime Minister Abe of Japan is in Ottawa
--April 28, Parliamentary sittings resume
--April 30, GDP numbers for February to be released
--April 30-May 1, U.S. Fed meets
The Morning Brief returns on Monday, April 28 and will review possible subjects for question period--bc