Bank of Canada pins hopes on the New Year

By Kevin Carmichael, The Globe and Mail


The Bank of Canada is looking past weaker economic growth, holding to a projection that Canada’s economy will gather pace next year.

Policy makers appear little moved by a report last week that showed Canada’s gross domestic product grew at an annual rate of 0.6 per cent in the third quarter, a poor showing that fell short of the Bank of Canada’s already dim projection for growth of 1 per cent in the July-August period.

The central bank acknowledged Tuesday that the third-quarter number was “weak,” but attributed part of the slump to “transitory disruptions” in the energy industry. Policy makers held to their view that ultralow borrowing costs will stir enough household consumption and business investment in the months ahead to avoid a prolonged slump. The Bank of Canada in October predicted the economy would expand at a rate of 2.5 per cent in the fourth quarter.

“Although underlying momentum appears slightly softer than previously anticipated, the pace of economic growth is expected to pick up through 2013,” the Bank of Canada said in a statement, as it held its benchmark interest rate unchanged at 1 per cent at the end of its latest round of policy deliberations.

The central bank’s response to the third-quarter growth figures suggests Bank of Canada Governor Mark Carney and his deputies on the governing council remain more inclined to raise interest rates than to lower them, although a change in stance is unlikely for some time.

Policy makers left in place their guidance on the likely path for interest rates, reiterating their view that “over time, some modest withdrawal of monetary policy stimulus will likely be required” to keep inflation from topping the central bank’s 2-per-cent target. “The timing and degree of any such withdrawal will be weighed against global and domestic developments, including the evolution of imbalances in the household sector,” the statement said.

Canada’s central bank finds itself in the unique situation of having to confront an unstable global economy while having to look over its shoulder at an uncomfortably large burst of household debt. On the opposite side of the world, faced with a resource boom that appears to have peaked, the Reserve Bank of Australia Tuesday cut its benchmark lending rate to 3 per cent, its level during the financial crisis, in a bid to spark domestic industries, including a lacklustre real estate market.

Canada’s overnight target stayed where it has been for more than two years. That’s an extremely low level, and it’s unusual to leave policy unchanged for such a long period; the last time the central bank left borrowing costs unchanged for this long was the early 1950s. As a result, murmurs that Mr. Carney is fuelling an unsustainable expansion of household debt and a housing bubble likely will persist.

The Bank of Canada noted that the housing market is beginning to cool, and the growth of credit is starting to slow. “It is too early, however, to determine whether the moderation in housing activity and credit growth will be sustained,” the statement said.

Some analysts said Canada’s central bankers should stop worrying about a housing bubble and focus on a deteriorating economy. Paul-André Pinsonnault, senior fixed-income economist at National Bank Financial in Montreal, said the economy’s problems extend beyond temporary issues in the energy industry. Corporate profits are declining, and hiring is stagnant. “We continue to see no reason for any rate hikes before 2014,” Mr. Pinsonnault said.

The Bank of Canada isn’t exactly sanguine. It reiterated that weak global growth – accentuated by a recession in Europe and a “gradual” recovery in the United States – is impeding exports.

Predicting where the global economy is headed is extremely difficult right now. The Bank of Canada said the deceleration of China’s economy has “stabilized,” which is a positive sign. At the same time, strained budget negotiations in Washington are holding back the U.S. recovery by making it impossible to predict tax policy. Until that cloud lifts, it also will be difficult to set Canadian monetary policy.