Economy rebounding, central bank says
Sean Kilpatrick/The Canadian Press
Bank of Canada maintains conditional commitment to keep borrowing costs at record low through middle of next year, but warns dollar could choke recovery
T
he Bank of Canada said Thursday the economy is growing at a faster pace than it expected and singled out a stronger currency as the major risk to recovery from the first recession since 1992.
Central bank Governor Mark Carney and his inner circle of advisers concluded their latest round of policy discussions with a decision to maintain their pledge to leave the benchmark target at a record low of 0.25 per cent until the middle of next year, barring an unforeseen burst of inflation.
In a statement, the central bank said economic and financial developments since July are “broadly” in line with what Mr. Carney and the rest of the Governing Council had anticipated.
Recent indicators, which include surveys that indicated global factory production is on the rise, “point to the start of recovery in major economies, supported by aggressive policy stimulus and the stabilization of global financial markets,” the Bank of Canada said.
Those factors, combined with firmer commodity prices, a rebound in business and consumer confidence, evidence that businesses are set to rebuild stockpiles and stronger demand for automobiles suggest that Canada's pace of economic growth over the second half will exceed the 2.15-per-cent annual rate predicted in July, the central bank said.
The central bank didn't offer a revised forecast. That will come when policy makers release their next quarterly economic report on Oct. 22.
The Bank of Canada's view that the recovery it heralded in July is on track was bolstered by fresh evidence that Canadian companies are benefiting from a global economy that is stirring from the deepest downturn since the Second World War.
Canadian exports increased 3.3 per cent in July from June, and imports surged 8.3 per cent, the first gain in five months, Statistics Canada reported Thursday.
Because imports grew faster than exports, Canada recorded a trade deficit of $1.4-billion in July. Still, analysts seized on the report as a positive sign that economic activity is coming back to life, bolstering a growing number of forecasts that Canadian GDP will expand this quarter.
“It is necessary to look beyond the widening in the deficit and see through to the rapid acceleration in trade volumes which is indicative of a pick up in economic activity,” Stewart Hall, an economist at HSBC Securities in Toronto, said in a note to clients. “By all appearances, the month of July finds Canada riding on the cusp of economic recovery.”
That leaves the dollar as the only threatening cloud on the Bank of Canada's horizon.
The currency was the only risk to the outlook that policy makers chose to cite in their latest statement. Policy makers repeated a warning they have been making since June, saying that too quick a march toward parity with the U.S. dollar could dampen growth to the point that the central bank would miss its inflation target of 2 per cent.
“Persistent strength in the Canadian dollar remains a risk to growth and to the return of inflation to target,” the statement said. “In its conduct of monetary policy at low interest rates, the bank retains considerable flexibility, consistent with the framework outlined the April [monetary policy report].”
Canada's dollar is rising because global demand for oil, gold and the other commodities it produces are also on the rise and because the country's economy remains relatively strong amid the wreckage of the financial crisis.
The other element driving the loonie's rise is speculation, which has the same stoking effect on fundamental demand that nitrous oxide has when racers mix it with gasoline.
It's the speculative pressure that Mr. Carney is trying to contain by pressing the point that a stronger currency could force him to seek ways to further lower borrowing costs – a shift that would make the dollar broadly less attractive.
Mr. Carney's focus is the central bank's inflation target of about 2 per cent, a goal policy makers are bound to reach by law. With inflation contracting at an annual rate of 0.9 per cent in July, Mr. Carney is counting on stronger growth to pull the rate back toward the target by the first half of 2011.
The central bank said Thursday it still expects inflation to trough in the currency quarter before returning to 2 per cent in the second quarter of 2011 “as aggregate supply and demand return to balance.”
There's some evidence the Bank of Canada's rhetoric about the currency is having some effect.
In May, the loonie soared 9 per cent, jumping to nearly 92 cents U.S. from less than 84 cents, the biggest one-month increase in modern times, according to Bank of Canada data.
That surge prompted the central bank's first warning about the currency, as policymakers used their June 4 policy statement to say that if May's “unprecedentedly rapid rise” proved persistent, it could “fully offset” early signs of recovery.
Since that statement, the loonie has averaged 89.9 cents since June 4, rising as high as 93.5 cents on Aug. 5 and falling as low as 85.7 cents on July 8.
In April, after dropping the overnight target to the lowest possible without roiling short-term money markets, policy makers said they were prepared to deploy exceptional measures to lower market interest rates to meet their inflation target.
The unprecedented pledge to leave rates at a specific level for a set amount of time was one of those measures. Mr. Carney said he also could create money to buy government bonds or corporate debt, which likely would lower bond yields, creating new demand for the securities. (The demand would raise prices, which move in an inverse relationship to yields.) Such a policy, called quantitative easing, also could ease the ascent of the loonie by adding to the supply of dollars and making interest-bearing Canadian assets less attractive.
The ability to deploy those measures is what the central bank means when it says it retains “considerable flexibility.” Speaking in Kingston, Ont. last month, Timothy Lane, a deputy governor, indicated the central bank would follow that course if an ever-rising dollar began to offset burgeoning confidence in a recovery.
Several economists, including Mr. Hall and Michael Gregory of Toronto-based BMO Nesbitt Burns, said the tone of the central bank's most recent comment on the currency suggests policy makers are comfortable with the loonie's trajectory of late.
Their reasoning was based on the usual attempt to read between the lines of the central bank's carefully worded public statements.
Mr. Hall noted that policy makers had moved their commentary on the currency to the second-to-last paragraph, creating separation with their broader assessment of the economy.
For his part, Mr. Gregory said he felt the statement watered down the possibility of using quantitative easing to slow the loonie's rise. When referring to the currency's rise last month, Mr. Lane said policy makers “would need to take that into account” when considering whether to deploy quantitative easing. That direct link was absent from today's statement, Mr. Gregory noted.
“It doesn't appear that the [Canadian dollar] alarm bells are ringing too loudly at the bank, at least for the time being,” Mr. Gregory said in a research note.
