Bank of Canada keeps interest rate at one per cent

OTTAWA _ The Bank of Canada warned Tuesday the economy is not performing as well as it should and could take more than two years before it returns to full capacity.

In a surprisingly bleak new forecast, the bank said the economy is too feeble to accommodate another interest rate hike.

The outlook accompanying the bank’s announcement that it will hold its policy interest rate at one per cent at least until December, and likely longer, sheds fresh light on what is in store for Canadians as the world struggles to climb out of a big recessionary hole.

The good news is that bank governor Mark Carney still sees no double-dip slump in the horizon, but that’s as good as it gets.

Carney, who until Tuesday had been among the economy’s biggest boosters, now sees a landscape of uncertainty.

“The economic outlook for Canada has changed,” the bank said.

“At this time of transition in the global recovery, with a weaker U.S. outlook, constraints beginning to moderate growth in emerging-market economies and domestic considerations that are expected to slow consumption and housing activity in Canada, any further reduction in monetary policy stimulus would need to be carefully considered,” it said.

In an unrelated release, the Conference Board also sliced its forecast for Canada to 2.5 per cent growth in 2011, adding that the risks to the global recovery were on the downside.

Markets had expected Carney to push the pause button, but not the cautionary language or the extent of revisions to the outlook. That partly explains why the loonie fell over two cents US in early morning trading before finishing the day down 1.7 cents at 96.91 US, analysts said.

The central bank now expects the economy to advance only three per cent this year _ mostly on growth that has already occurred _ then just 2.3 per cent next year and 2.6 per cent in 2012. The first two years are about half-a-point lower than the bank’s July estimate.

The biggest shock was that Carney now thinks the economy will return to full capacity only at the end of 2012, one full year later than previously thought.

Economists say Carney and senior bank officials are now coming around to what they had been saying for months _ that the economy has been braking hard.

Many forecasters have predicted growth will hover around 1.5 per cent in the just completed third quarter, after gains of 2.0 and 5.8 per cent the previous two periods.

Carney cited weakness the U.S., slowing growth in the emerging world, the withdrawal of government stimulus, and high household indebtedness in Canada as contributing factors to the expected slow pace going forward.

Now that the consumer is tapped out, Canada must count on business investment and exports for future growth, both weak links the past few years, the bank said.

The non-action by the central bank Tuesday gives Carney room, in theory, to move either way on interest rates, But in reality the bank is likely to stay glued to the one per cent rate for the next six to 12 months, analysts said.

With the U.S. Federal Reserve and other important central banks using their muscle to deflate national currencies, Canada’s central bank can ill afford to offer another boost to the loonie while the economy is struggling.

IHS Global Insight chief economist Brian Bethune believes Carney’s previous moves to raise interest rates have already played a role in the loonie’s summer rally, putting added pressure on domestic producers and exporters.

“The problem with that is that it encourages hot money flows into Canada and pushed up the Canadian dollar, and all that does is hurt small business,” he said.

Super low rates for extended periods also carry a considerable risk, however, noted Derek Holt, vice-president of economics with Scotiabank. They could create asset bubbles, particularly in the housing market, that distort the economy years later.

“I think the (Bank of Canada) is walking a really fine line, but they really don’t have much of a choice,” he said.

“Actions by the Fed and others are just tying the hands of the peripheral central banks, like the Bank of Canada, and committing them to a longer low-rate path than would otherwise be advisable.”

Without specifically mentioning it, the bank implied a key to untangling the global mess, particularly in advanced economies, lies with negotiations at the G20 later this week and in November over currency manipulation, particularly by China.

“Heightened tensions in currency markets and related risks associated with global imbalances could result in a more protracted and difficult global recovery,” the bank said.

China has recently moved to address some of the complaints of the U.S. and other advanced economies, letting its yuan appreciate modestly and, on Tuesday, tightening monetary policy.

But that is unlikely to satisfy the United States, which has a massive trade imbalance with the emerging giant. And as long as the U.S. remains weak, Canada, which sends 70 per cent of its exports south of the border, will find it difficult to get going,  analysts said.

Top Stories

Top Stories

Most Watched Today