The Bank of Canada's Monetary Policy Report – raises 2010 inflation profile though does not signal change to policy outlook
In the final analysis, the details of the Bank's forecast show a mild nudge up in its expectation for growth in Canada's economy over the next couple of years. The 2010 real GDP forecast was trimmed back to 2.9% from 3.0%, while 2011's forecasted growth rate rose to 3.5% from 3.3%. Not significant changes on either year's growth rate, but they balance out to a 0.1% overall increase compared to the October projection. The Bank was more aggressive in terms of upgrading its forecast for the global economy with world GDP growth forecasted to increase by 3.7% in 2010 (from 3.1% in October) and 4.1% in 2011 (from 4.0%). In terms of its outlook for inflation, the Bank boosted the 2010 headline and core forecasts. The updated forecast looks for the core rate to average 1.6% in the first-quarter 2010 (from 1.4% in October) and 1.7% for the entire year (from 1.5% in the previous forecast). The headline rate was also bumped up in 2010 and forecasted to average 1.8% (from 1.4%). Forecasts for core rate were unchanged in 2011 while the headline rate is expected to be one-tenth higher in the first quarter of 2011 and then settle back into the prior forecast.
The other notable change in the forecast was oil prices, which are assumed to be higher over the forecast horizon, averaging $83.50 in 2010 (from $76.5) and $88.00 in 2011 from ($80.00). The assumed level of the Canadian dollar was unrevised at 96 U.S. cents, and the Bank still expects non-energy commodity prices to increase "progressively" and credit conditions to "gradually improve."
The report presented changes to the quarterly profile for growth in Canada's economy throughout 2010 and the first quarter of 2011. Growth is expected to be slightly milder in the first quarter of 2010 but to accelerate at a faster pace in the following four quarters. The combination of a strong Canadian dollar and weak U.S. demand will weigh on net exports, which are forecasted to trim 1.2% from the 2010 growth rate. Imports are expected to increase at a faster pace than exports this year likely helped along by the stronger currency making purchases from abroad less expensive. In 2011, however, higher commodity prices and a stronger U.S. economy will see net exports contribute to growth in this update, a switch from the October outlook, which forecasted that the sector would restrain overall growth in 2011.
Government expenditure, which was a key support for the economy from 2008 to 2010, will act as a small drag in 2011 as funds flowing from the stimulus package evaporate. Consumer spending and business fixed investment combined with inventory rebuilding will take up the mantle and support the economy next year. To that end, the Bank discusses the risks to the outlook in the context of a stronger-than-expected recovery in the global economy and Canadian domestic demand on the upside being balanced off against weaker net exports due to a stronger Canadian dollar on the downside for Canada's economy.
With the macro risks judged to be balanced, the Bank views the risks to its inflation outlook as slightly tilted to the downside due to the current policy rate being at the effective lower bound. Once again, the Bank discusses this tilt in the risk profile in the context that it could respond to stronger-than-expected growth with a traditional policy response (raise the overnight rate). However, because the rate is already at its lower bound, should the downside risks materialize, the Bank would have to employ "unconventional policies."
The slight revision to growth over this two-year period resulted in no change in the timing of the closure of the output gap (the difference between actual GDP and an estimate of potential GDP where all inputs are fully utilized) from its October estimate, which is expected to occur in the third quarter of 2011. At the same time, inflation is forecasted to return to the 2% mid-range target. In order to ensure that the inflation rate does not exceed the 2% target, the Bank will need to return the overnight rate to a neutral level, and we expect the process to begin this summer because of the lags between changes in monetary policy and their impact on the economy. Our economic forecast points to the process of rate neutralization starting this summer, and we look for 100 basis points of rate increases to be implemented before the end of the year with another 225 basis points in 2011.
Dawn Desjardins, Assistant Chief Economist, RBC Economics
In the final analysis, the details of the Bank's forecast show a mild nudge up in its expectation for growth in Canada's economy over the next couple of years. The 2010 real GDP forecast was trimmed back to 2.9% from 3.0%, while 2011's forecasted growth rate rose to 3.5% from 3.3%. Not significant changes on either year's growth rate, but they balance out to a 0.1% overall increase compared to the October projection. The Bank was more aggressive in terms of upgrading its forecast for the global economy with world GDP growth forecasted to increase by 3.7% in 2010 (from 3.1% in October) and 4.1% in 2011 (from 4.0%). In terms of its outlook for inflation, the Bank boosted the 2010 headline and core forecasts. The updated forecast looks for the core rate to average 1.6% in the first-quarter 2010 (from 1.4% in October) and 1.7% for the entire year (from 1.5% in the previous forecast). The headline rate was also bumped up in 2010 and forecasted to average 1.8% (from 1.4%). Forecasts for core rate were unchanged in 2011 while the headline rate is expected to be one-tenth higher in the first quarter of 2011 and then settle back into the prior forecast.
The other notable change in the forecast was oil prices, which are assumed to be higher over the forecast horizon, averaging $83.50 in 2010 (from $76.5) and $88.00 in 2011 from ($80.00). The assumed level of the Canadian dollar was unrevised at 96 U.S. cents, and the Bank still expects non-energy commodity prices to increase "progressively" and credit conditions to "gradually improve."
The report presented changes to the quarterly profile for growth in Canada's economy throughout 2010 and the first quarter of 2011. Growth is expected to be slightly milder in the first quarter of 2010 but to accelerate at a faster pace in the following four quarters. The combination of a strong Canadian dollar and weak U.S. demand will weigh on net exports, which are forecasted to trim 1.2% from the 2010 growth rate. Imports are expected to increase at a faster pace than exports this year likely helped along by the stronger currency making purchases from abroad less expensive. In 2011, however, higher commodity prices and a stronger U.S. economy will see net exports contribute to growth in this update, a switch from the October outlook, which forecasted that the sector would restrain overall growth in 2011.
Government expenditure, which was a key support for the economy from 2008 to 2010, will act as a small drag in 2011 as funds flowing from the stimulus package evaporate. Consumer spending and business fixed investment combined with inventory rebuilding will take up the mantle and support the economy next year. To that end, the Bank discusses the risks to the outlook in the context of a stronger-than-expected recovery in the global economy and Canadian domestic demand on the upside being balanced off against weaker net exports due to a stronger Canadian dollar on the downside for Canada's economy.
With the macro risks judged to be balanced, the Bank views the risks to its inflation outlook as slightly tilted to the downside due to the current policy rate being at the effective lower bound. Once again, the Bank discusses this tilt in the risk profile in the context that it could respond to stronger-than-expected growth with a traditional policy response (raise the overnight rate). However, because the rate is already at its lower bound, should the downside risks materialize, the Bank would have to employ "unconventional policies."
The slight revision to growth over this two-year period resulted in no change in the timing of the closure of the output gap (the difference between actual GDP and an estimate of potential GDP where all inputs are fully utilized) from its October estimate, which is expected to occur in the third quarter of 2011. At the same time, inflation is forecasted to return to the 2% mid-range target. In order to ensure that the inflation rate does not exceed the 2% target, the Bank will need to return the overnight rate to a neutral level, and we expect the process to begin this summer because of the lags between changes in monetary policy and their impact on the economy. Our economic forecast points to the process of rate neutralization starting this summer, and we look for 100 basis points of rate increases to be implemented before the end of the year with another 225 basis points in 2011.
Dawn Desjardins, Assistant Chief Economist, RBC Economics
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