Bank of Canada holds rate steady, but chops growth forecast

Gordon Isfeld, The Financial Post

OTTAWA — Canada’s economic fate could rest strongly on our neighbours to the south, just as long as the crisis in Europe remains contained.

The Bank of Canada is putting stock in a modest recovery in the United States to lift exports and investment in this country, which itself will see slower growth than previously thought.

In its quarterly Monetary Policy Report, released Wednesday, the bank said it now anticipates growth of 1.5% this year, down from 2% projected in the January MPR. In 2014, the economy is pegged to expand by 2.8%, compared with the previous estimate of 2.7%.

Overall, global growth is set at 3% this year, up from the earlier forecast of 2.9%, and 3.6% in 2014, also up slightly from the January estimate of 3.5%.

Tuesday’s outlook from the International Monetary Fund mirrored the bank’s prediction of 1.5% this year, while its estimate for 2014 came in at a slightly lower 2.4%. Globally, the IMF said output would reach 3.3 % in 2013 and 4% next year.

Elsewhere, the bank said the U.S. economy is continuing to expand “at a modest pace,” with the gradually strengthening private demand partly offset by accelerating fiscal conditions.” Policy-makers expect U.S. growth of 2% in 2013 and 3.1% next year.

Never in doubt was the decision by policy-makers to keep its trendsetting interest rate at its near-historic low of 1%, where it has stood since September 2010 as the bank encouraged spending to drive recovery from the 2008-09 recession.

At the same time, the bank is doggedly sticking to its theme that interest rates will eventually be going up, not down.

Significantly, there was no change Wednesday in the bank’s guidance on rates. Some economists had been looking for policy-makers to weaken their slant toward raising borrowing costs.

Instead, the bank’s statement reiterated that the current key rate “will likely remain appropriate for a period of time,” and again citing “continued slack in the Canadian economy, the muted outlook for inflation, and the constructive evolution of imbalances in the household sector.”

Growth in consumer spending, which has pushed household debt-to-income ratios to record highs, is likely to continue a recent slowing trend, the bank said, reflecting “moderate increases in consumption and further declines in residential investment.”

Still, the bank remains cautious about the residential housing market overall. “Despite the recent moderation in the rate of new housing construction, there are still signs of overbuilding, particularly of multi-unit dwellings in some urban areas.”

The Toronto and Vancouver condo markets have attracted the most attention from the policy-makers at the central bank, as well as Finance Minister Jim Flaherty — who in July tightened lending rules on government-insurance mortgages and, more recently, warned financial institution against encouraging consumers to plow into the housing market by offering record-low five-year fixed lending rates.

Business investment and exports, meanwhile, have been slow to kick in and take over as the drivers of the economy.

“Following a weak second half of 2012, growth in Canada is projected to regain some momentum through 2013 as net exports pick up and business investment returns to more solid growth,” the bank said.

“Despite the projected recovery in exports, they are likely to remain below their pre-recession peak until the second half of 2014 owing to restrained foreign demand and ongoing competitiveness challenges, including the persistent strength of the Canadian dollar.”

Help could be on the way, though, with the housing recovery in the United States “delivering important benefits to the Canadian economy.”

Growth in U.S. residential investment will “would be expected to boost Canadian export growth by an average of roughly 1% per year based on historical relationships,” the bank argues.

“The higher income and wealth in the United States generated by the housing recovery will also lead to higher U.S. consumption, further raising demand for Canadian exports. The most direct benefits to Canada will be felt by the forestry sector and other construction-related exports.”

As for inflation, the bank’s main policy target, the level of price increases is expected to remain “subdued in coming quarters” before reaching the optimum level of 2% by mid-2015.