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Bank of Canada cuts economic outlook, drops rate hike signal

BARRIE MCKENNA

OTTAWA — The Globe and Mail

Published Wednesday, Oct. 23 2013, 10:02 AM EDT

Last updated Wednesday, Oct. 23 2013, 11:41 AM EDT

The Bank of Canada has abruptly abandoned an explicit warning that its key interest rate is headed higher in the face of a much gloomier economic outlook.

Cautioning that Canada is likely to grow much more slowly than it thought in the summer, the central bank now acknowledges that its next move is just as likely to be a rate cut, as an increase.

The surprise decision Wednesday to drop its so-called tightening bias – in place since April 2012 – coincides with a significant downgrade of the bank’s forecast for GDP growth in Canada.

The bank is cutting its forecast for both the Canadian and U.S. economies – not just for this year, but for 2014 and 2015 as well.

The bank pointed to an economic environment that is now “less favourable for Canada” – most notably, the painfully slow recovery from recession in the United States, Canada’s main trading partner.

“Uncertain global and domestic economic conditions are delaying the pick-up in exports and business investment, leaving the level of economic activity lower than the bank had been expecting,” the Bank of Canada said in a statement.

For the moment, Canada’s export problem is that it is still far too dependent on the U.S., which is grappling with a sluggish recovery and poisoned budget politics in Washington.

The bank left its overnight interest rate unchanged at the one per cent, where it’s now been since September 2010. The bank’s next rate-setting decision is Dec. 4.

Many economists now don’t expect a Bank of Canada rate hike until late 2015, or even 2016.

The Bank of Canada has been anticipating that exports and business investment would pick as the consumer-driven domestic economy cooled, along with the housing market.

But that isn’t happening. Business confidence remains weak and exports are still weak, failing to regain pre-recession levels.

That means the economy isn’t likely to return to “full production capacity” until the end of 2015, according to the bank, or six years after the recession ended. The bank had previously estimated that the so-called output gap would close in mid-2015.

The bank slashed its closely watched forecast of annual GDP growth in Canada to 1.6 per cent this year, down from the 1.8 per cent it forecast in July, and to 2.3 per cent in 2014, down from its earlier forecast of 2.7 per cent. In 2015, it expects growth of 2.6 per cent, versus 2.7 per cent previously.

The bank also said it expects the U.S. economy will grow just 1.5 per cent this year and 2.5 per cent in 2014. That’s down from its earlier forecasts of 1.7 per cent and 3.1 per cent respectively.

Bank of Canada deputy governor Tiff Macklem previewed the GDP downgrade in an Oct. 1 speech in which he highlighted the country’s declining share of global trade.

Dating back to April of last year, former Bank of Canada Mark Carney and his successor Stephen Poloz have insisted the bank would raise the overnight rate to a more normal level “over time.”

That important caveat has now been stricken from the bank’s statement.

“The fact that inflation has been persistently below target means that the downside risks to inflation assume increasing importance,” the bank said Wednesday.

Inflation has been consistently below the bank’s 2 per cent target since early 2012.

Beyond the U.S. and Canada, the economy is generally doing better than expected. In its statement, the bank said the nascent European recovery, “while modest, has surprised to the upside.” And China’s economy is showing “renewed momentum,” the bank said. And the Japanese economy is also doing better.

At home, the bank said consumer spending is holding up better than expected and remains “solid.” The Bank of Canada also continues to expect a “gradual unwinding of household imbalances.”

Many economists have fretted about Canadians’ soaring level of debt to income as low interest rates spurred a long housing price boom in much of the country. Higher mortgage rates could put many homeowners under pressure. But it’s the export sector that really worries the bank.

In its quarterly monetary policy report, also released Wednesday, the bank said the export sector has been “lackluster” in the second and third quarter, with the exception of autos and forest products.

“The recent weakness in exports is indicative of a broader trend of slower-than-expected export growth that began in early 2012,” the bank. It said this is due to “shifts in trade linkages” and ongoing competitive challenges.”