Bloomberg News

Bank of Canada Cuts Growth Outlook as U.S., Europe Falter

October 26, 2011

(Updates with analyst comment in fifth paragraph, Carney comments in 15th, 16th paragraphs.)

Oct. 26 (Bloomberg) -- The Bank of Canada cut its forecasts for economic growth through the middle of 2012 as the U.S. and European economies falter, and it said the expansion will accelerate more than estimated later next year.

The bank, in its quarterly Monetary Policy Report, said the annualized pace of expansion in the world’s 10th largest economy will average 1.8 percent in the four quarters through June, compared with a previous estimate of 2.8 percent. The bank cut its projection for global growth in 2012 by 0.9 percentage point, and it said the recovery will be slower than usual as consumers, governments and businesses reduce debt.

“Lower commodity prices and heightened volatility in financial markets stemming from the weaker and more uncertain global economic outlook are projected to weigh on the wealth and confidence of Canadian households,” the report said. Its projection assumes a “gradual reduction in monetary stimulus over the projection horizon, consistent with achieving the inflation target.”

Household spending and business investment will accelerate in 2013, assuming European leaders are able to contain their debt crisis, the bank said, bringing inflation back to its 2 percent target rate. The bank’s projection for the U.S. economy doesn’t include President Barack Obama’s proposed $447 billion jobs package, which includes infrastructure spending and tax cuts.

‘Too Dire’

“In a few cases, the Bank of Canada’s making assumptions that might be too dire, particularly in assuming that the U.S. will reject everything that Obama has proposed,” said Avery Shenfeld, chief economist at the Canadian Imperial Bank of Commerce, in a phone interview.

Toronto-based CIBC is sticking to its forecast that the Bank of Canada won’t increase its main lending rate until the second half of next year, Shenfeld added.

Today’s report follows yesterday’s announcement by the central bank that it will keep its target for the overnight interest rate at 1 percent, extending a yearlong freeze and prompting investors to bet Governor Mark Carney will be reluctant to diverge far from the Federal Reserve on changes to borrowing costs.

Canadian two-year bond yields yesterday fell the most since Aug. 8 after the bank’s statement. Yields pared declines today, advancing 6 basis points to 1.05 percent at 1:44 a.m. in Toronto. Canada’s currency appreciated 0.9 percent to C$1.0074 per U.S. dollar. One Canadian dollar buys 99.26 U.S. cents.

Extended Pause

Craig Alexander, chief economist at Toronto-Dominion Bank, said the downward revision in growth signals Carney will extend his pause on borrowing costs to as late as 2013, in line with the Fed.

“There is a limit to how much the Bank of Canada can raise rates before the Federal Reserve” does the same, Alexander told reporters in Ottawa yesterday. “The Bank of Canada won’t be raising interest rates until the early part of 2013, and then we will only get a gradual rise.”

In a May 16 speech, Carney said that recessions involving financial crises are deeper and have recoveries that take twice as long.

“Although the current U.S. economic recovery is the weakest since the Great Depression, it is in line with average recoveries seen in other advanced economies that have experienced major financial crises,” the bank said in today’s report.

Modest Exports

“Still-elevated levels of household debt, weakness in the U.S. housing and labor markets, and the need for fiscal consolidation all imply that growth in U.S. domestic demand -- and hence, growth in demand for Canadian exports -- will remain modest for the foreseeable future,” it said.

Still, given the country’s borrowing costs are at “historic lows,” it is reasonable to expect the country’s policy rate will be higher by the end of 2013, Carney said.

“It’s a very low bar to say there is an expectation that some monetary-policy stimulus would be removed over the course of the next 27 months,” Carney told reporters at a press conference in Ottawa following the release of his report.

The central bank cut its outlook for exports from its last quarterly forecast in July, projecting they will contribute 0.9 percentage points to growth next year, down from 1.1 percent.

Consumption will contribute 1.2 percentage points to 2012 growth, down from a July estimate of 1.6 percent, while business investment will add 0.7 percentage points, down from a 1.1 point contribution the bank predicted in its last report.

Low Inflation

Canada’s inflation will reach a low of 1 percent in the second quarter of next year, while core inflation, which strips out eight volatile components and is used by the Bank as a guide to future inflation, will slip to 1.6 percent by the end of 2012. Both inflation measures are forecast to return to 2 percent at the end of 2013.

The Canadian economy probably expanded at an annualized pace of 2 percent in the third quarter and will grow at a 0.8 percent rate in the fourth quarter, the central bank predicted.

Growth will accelerate to a 1.9 percent pace in the first quarter of next year and 2.5 percent in the second quarter, it said. The economy will grow at a 3 percent rate for the last six quarters of its projection horizon, which will bring the economy back to its capacity by the end of 2013.

The bank said Canada’s economy was operating about 1.25 percent below its level of capacity in the third quarter, compared with a gap of slightly less than 1 percent in the second quarter.

Slower Global Growth

Global economic growth will be 3.1 percent next year, the central bank predicted, down from a July estimate of 4 percent. The euro area will expand at a 0.2 percent pace, it predicted.

The U.S. economy will grow by 1.7 percent in 2012, though it will remain weak in the first half, with average growth of 1.25 percent, levels at “which the probability of recession increases,” the bank said.

The Bank of Canada revised its estimates for potential output growth, the central bank’s assumption on how quickly the economy can growth “on a sustained basis” without adding to inflation pressures. The central bank estimated the country’s potential growth rate to be 1.6 percent in 2011, 2 percent in 2012, 2.1 percent in 2013 and 2.2 percent in 2014.

--With assistance from Ilan Kolet in Ottawa. Editors: Paul Badertscher, Christopher Wellisz

To contact the reporter on this story: Theophilos Argitis in Ottawa at targitis@bloomberg.net;

To contact the editors responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net; David Scanlan at dscanlan@bloomberg.net.


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