BoC cites low inflation in maintaining stimulus interest rate in place at 1%

OTTAWA – The Bank of Canada says it sees some encouraging signs in the Canadian and global economies, but the improvement is not sufficient and inflation remains too low to justify moving off its view that the recovery remains fragile and in need of monetary stimulus.

As expected, the bank on Wednesday once again decided to keep in place its key rate at one per cent, a level that has helped keep borrowing costs near historic lows for several years, thereby encouraging economic activity.

Canada’s dollar dropped shortly after the bank’s announcement, hitting levels that it hasn’t visited since May 2010.

The announcement, the central bank’s last for the year, suggests it has not materially changed its mind about the trend of the economy since October’s rather gloomy monetary policy report, despite the fact that third-quarter growth was far stronger than its estimates.

Bank of Canada had expected the July-September period to record 1.8 per cent advance in real gross domestic product, but Statistics Canada reported 2.7 per cent annualized growth, the best quarter in two years.

The bank said Wednesday that underlying conditions were actually weaker than it appeared, noting that sustainable growth requires rotation from domestic activity — in particular housing and consumer spending — to more export growth and businesses spending.

“Real GDP growth in the third quarter … was stronger than the bank was projecting, but its composition does not yet indicate a rebalancing towards exports and investment,” it said. “Business investment spending is up from previous low levels, but is still recovering more slowly than anticipated.”

As bank governor Stephen Poloz emphasized in October and at recent appearances before Commons and Senate committees, the bank’s governing council is particularly focused on the low inflation rate, as an indicator of persistent slack in the economy.

In fact, the inflation picture has gotten worse in the past month and a half, the bank said, with the headline rate dropping below the bank’s broad one-to-three per cent target range to 0.7 per cent.

“Core inflation is being held down by significant excess supply and by the effects of heightened competition in the retail sector, which look to be more persistent than anticipated,” it said, in possible reference to new entrants in the Canadian market, such as the Target chain.

“On balance, the bank sees no reason to adjust its expectation of a gradual return to full production capacity around the end of 2015,” it concluded.

That assessment is unlikely to significantly change the opinion of most economists and markets that Poloz expects to stay on the sidelines as far as adjusting interest rates throughout 2014, and that the first change will be a 25-basis point increase in the overnight rate sometime in 2015.

The bank took note of the recent resurgence in the Canadian housing market, but said it was “consistent with updated demographic data” and the view that some buyers jumped into the market to get ahead of expected mortgage rate increases.

“The bank continues to expect a soft landing in the housing market,” it said. “The risks associated with elevated housing imbalances have not materially changed.”

As for the global economy, it notes that it is expanding “at a modest rate” as expected, while being encouraged that U.S. growth was stronger than expected in the third quarter, “even if this pickup was due to temporary factors.”