Bank of Canada's Monetary Policy Report Warns of Gloomier Outlook

Downbeat Assessment

The Bank of Canada's semi-annual Monetary Policy Report (MPR) provides the Bank's views on the performance of the Canadian economy, as well as its forecast for key indicators related to monetary policy. In the April 2008 report, the first since Mark Carney was appointed governor in February, the Bank downgrades its expectations for Canada's growth for both this year and next. The deeper and longer downturn in the United States, financial market strife, and weaker global growth have compounded to lower the growth forecast for Canada from the 1.8% 2008 forecast in January to just 1.4%. This would be the weakest Canadian growth since the 0.9% recorded in 1992, when the country was emerging from the previous year's recession. For 2009, growth is expected to be a bit stronger, at 2.4%, rising to 3.3% in 2010. Domestic demand continues to be very strong (and should power a mild recovery in the second half of 2008), but the economy is dragged down by a negative and worsening trade balance. This weak trade picture is in turn due to the combination of continued adjustment to the high Canadian dollar, weakening U.S. growth, and industry-specific weaknesses in autos and forestry exports.

After operating beyond capacity, the Canadian economy has now moved to a sustainable pace, but an output gap is likely over the next two years. Inflation is now running below the mid-point of the inflation target band. The Bank's assumptions for oil prices are based on a considerably stronger forecast than that of Global Insight. Specifically, this forecast sees WTI oil falling from yesterday's near-US$120 level only as far as $102 by 2010. Non-energy commodities are predicted to be in for a steeper decline over the coming year. The Bank's forecast for U.S. growth, at 1.0% for this year, is just a shade shy of the current Global Insight forecast.

Government Under Pressure

Conservative Prime Minister Stephen Harper could face a general election in a matter of months, and is keen to defend his response to the slowdown. In an address to a chamber of commerce shortly after the MPR's publication, Harper stressed that Canada is in a better position than most other advanced economies to ride out the global economic crisis. He argued that debt and tax reductions implemented by the government have provided timely fiscal leeway and stimulus. He characterised the opposition Liberals' policies as meaning higher federal spending and hence higher taxation. The economy looks set to dominate the election when it comes—and all the more so if the Bank's projections prove optimistic. While in power the Liberals oversaw remarkably consistent strong performance, something they will be sure to remind voters of in the current climate. Harper will stress in turn that it is outside factors that are to blame. It remains to be seen which side proves the more convincing to voters. Should the economy slow sharply Harper will come under pressure to offer a direct fiscal stimulus package along the lines of the current hand-out in the United States. So far he has resisted, preferring instead to stick to tax cuts.

Outlook and Implications

Generally, the Bank's analysis of the Canadian economy and its expected performance is consistent with the current Global Insight forecast. The latest data in the report do, however, lead to slight downward pressure on our current 1.6% forecast for Canada's growth over 2008. As it should, the Bank notes risks to its forecast, including several realistic threats to inflation. Stronger domestic demand and tight labour markets in Canada could push up wages, and weaker labour productivity, stronger commodity prices, or worsening food inflation are also on the inflation watch list. On the other hand, even weaker growth in the United States, weaker commodity prices, worse financial conditions, and/or credit tightening could lead to weaker growth and lower inflation.

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