Bank of Canada Governor Stephen Poloz said confidence about global demand is bringing a “tipping point” where business investment takes over the lead in output growth from “tired” consumers and erases slack in the economy without rapid inflation.
Stronger exports will bolster confidence and foster new capacity-building investment, reversing a trend of low capital spending in industries outside of resources, Poloz, 57, said in a speech today to the Vancouver Board of Trade.
“Evidence suggests we are now close to the tipping point from improving confidence into expanding capacity,” said Poloz. “The economy should be able to support stronger activity without stoking inflation, as investment ticks upward,” he said.
Investors are betting Poloz will extend a three-year pause, the longest since the 1950s, by keeping his 1 percent benchmark interest rate unchanged until the end of next year. Recent reports have shown faster-than-expected gains in manufacturing sales and employment, suggesting the economy may be starting to pick up after slowing in the second quarter.
“The Governor presented his wish list for the Canadian economy and explained how he saw those wishes being fulfilled,” Krishen Rangasamy, senior economist at National Bank Financial in Montreal, wrote in a research note. “We are a touch less optimistic, concerned about the permanent loss of market share by our exporters.”
The Canadian dollar was little changed at C$1.0299 per U.S. dollar at 1:41 p.m. in Toronto. One dollar buys 97.10 U.S. cents.
Business fixed-capital investment fell at a 0.5 percent pace in the second quarter after a 1.3 percent decline in the prior three months, Statistics Canada reported Aug. 30. Part of the drop stemmed from reduced work on non-residential buildings during the Quebec strike, the agency said.
The central bank is projecting a “solid pace” of export growth that will lead to a “broadly based” increase in investment and provide incentives for new businesses to form, Poloz said. Strong corporate balance sheets, cheap funding and access to credit mean the “preconditions” are in place for faster capital spending, he said.
“With potential output higher and growing faster in response to investment,” Poloz said, slack in the economy “could close later than if investment and, ultimately, potential did not respond to demand.”
Historically, there has been a six-month lag between an improvement in exports and accelerated investment growth, Poloz said.
“Once there is a shift in sentiment, research shows that business decision-makers tend to react and move forward very quickly with their investment plans,” Poloz said. “We are optimistic that the gathering momentum in foreign demand, especially in the United States, should help lift the confidence of Canada’s business leaders and exporters.”
Poloz said there are encouraging signs that process is under way, citing declining financial market volatility and data that show an increase in the number of firms operating in the country.
Poloz said the global financial crisis had left a “7-year crater” that policy makers have been filling with liquidity to support the world economy.
“If it’s a seven year crater, then the implicit argument is consistent with the Bank of Canada’s forecasts that the output gap doesn’t close until mid-2015,” Derek Holt, vice president and economist at Scotiabank in Toronto, said in a note to investors. “We think that is consistent with a prolonged hold by the Bank of Canada until rate hikes commence around mid-2015.”
Any decision by the Federal Reserve to slow monthly bond buying is a “welcome sign that things are getting back to natural growth,” Poloz said. The U.S. economy “is clearly healing,” Poloz told the audience in a question-and-answer session after the speech, adding that Canada’s monetary policy would focus on the bank’s 2 percent inflation target and doesn’t need to “mimic” the Fed.
Canada’s economy will eventually reach a more normal state where growth will be “self-generating and self-sustaining,” and not reliant on record-low interest rates, Poloz said. In that state, inflation will be back to the central bank’s 2 percent target, policy rates will be above inflation and the unemployment rate will be down to a more “natural level.” Poloz did not say when the bank expects this.
Poloz said there are signs of a “soft landing” in the country’s housing market even after the ratio of consumer debt to disposable income reached a record 163.4 percent in the second quarter. Consumers are “tired” after the rise in debt levels, which he said will decline as incomes rise faster and after policy makers tightened lending rules.
“I have said before and I will say again I don’t perceive that there is a bubble in Canada’s housing market,” Poloz said at a press conference after the speech in the city that policy makers have singled out as a market that may have overheated.
At his last interest-rate decision on Sept. 4, Poloz said that “a gradual normalization of policy interest rates” can be expected as inflation returns to target and excess capacity in the economy is used up.
Consumer prices advanced 1.3 percent in July, the 15th straight month the rate was slower than the bank’s 2 percent target.
Output growth slowed to a 1.7 percent annualized pace in the second quarter, including a monthly decline of 0.5 percent in June that was the biggest since the 2009 recession. Growth slowed from 2.2 percent in the first quarter as business investment and energy exports declined.
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