Poloz Says Fiscal Boost Halted BoC Return to Rate-Cut Bias

Doyle: 'Worst of Both Worlds" Scenario on The Table
  • Canada's central bank keeps benchmark interest rate at 0.5%
  • Policy makers raise 1Q GDP forecast to 2.8%, cut 2Q to 1%

Bank of Canada Governor Stephen Poloz said he might have been inclined to cut interest rates if the federal government hadn’t delivered a dose of fiscal stimulus.

The Bank of Canada stood pat on rates Wednesday and released projections riddled with signs there would be little momentum in the nation’s economy without the impetus from new government spending. Global growth estimates, along with projections for net exports and energy investment, have been cut since the last monetary policy report in January, when Poloz acknowledged he started meetings with a bias toward cutting rates.

“The shocks that we’ve introduced in this forecast were primarily negative shocks,” Poloz told reporters in Ottawa after the decision, citing the impact of lower energy investment, a recent rebound in the currency and disappointing global growth. “So there is no doubt in my mind that we would have at least had that same bias going into the discussion.”

April’s projections suggest that while the additional government measures are easing pressure on the central bank, the underlying economy is still suffering from the long-term effects of collapsing oil prices. That might have prompted a “modest downgrade of the Bank’s outlook,” policy makers led by Poloz said in a statement Wednesday. However, fiscal measures from Prime Minister Justin Trudeau’s government “will have a notable positive impact,” they said. 

Pessimism Remains

“You can’t rule out that they would cut interest rates again,” Paul Ferley, assistant chief economist at Royal Bank of Canada, said by phone from Toronto. “With them saying they could have been forced to revise down growth, it’s an indication they remain concerned about the economy.”

The Canadian currency, which initially reversed losses after the rate announcement, resumed declines during the press conference, trading 0.4 percent lower at C$1.2814 against its U.S. counterpart at 12:35 p.m. in Toronto.

Policy makers kept the benchmark rate on overnight loans between commercial banks at 0.5 percent, where it’s been since two cuts last year. Gross domestic product will grow 1.7 percent this year instead of the 1.4 percent the bank expected in January, and full capacity will be reached in the second half of 2017 rather than “around the end” of that year.

Fiscal Assumptions

Government spending will boost Canada’s economic growth rate by 0.5 percentage point this year and 0.6 percent in 2017, the bank said, accepting the assumptions laid out in Finance Minister Bill Morneau’s debut budget last month.

Business investment will reduce Canada’s growth rate this year by 0.8 percent, a greater drag than the 0.5 percent projected in January. Energy investment will plunge by 60 percent this year from where it was in 2014, the bank said. Overall investment will start gaining in the second half of the year as non-energy companies benefiting from a lower Canadian dollar boost capacity to fill orders, the bank said.

Poloz also downplayed a surge in growth to a 2.8 percent annualized pace in the first quarter, and the bank cut its forecast for second-quarter growth to 1 percent on slower consumer spending and exports.

‘Temporary Factors’

“Some of this strength represents a catch-up after temporary weakness in the fourth quarter, and some of it reflects temporary factors that will unwind in the second quarter,” Poloz said at the press conference.

The bank cut next year’s growth forecast to 2.3 percent, from 2.4 percent in January, expecting exports to contribute 0.9 percent instead of 1.7 percent.

Inflation won’t hold at the central bank’s 2 percent target until the second half of next year, which is “somewhat earlier than anticipated in January,” according to the bank’s new quarterly economic forecast paper, the Monetary Policy Report.

Inflation slowed to 1.4 percent in February from a year earlier, down from the January pace of 2 percent, Statistics Canada reported March 18. The core index that strips out eight volatile products was 1.9 percent.

Road Ahead

Still, the elements of a recovery are in place, Poloz said.

“It does appear that the positive forces at work in the economy are starting to outweigh those that are negative,” the bank said. Policy makers reiterated that the adjustment to lower commodity prices was “complex” and there’s material excess capacity in the economy.

The return to full capacity and higher inflation is aided by a markdown of the bank’s estimate of how fast the economy can grow before price gains accelerate. The measure known as potential output growth was lowered to a range of 1.2 percent to 1.8 percent for this year, from 1.4 percent to 2.2 percent.

Exports outside the battered energy industry remain the main hope for a recovery in the bank’s projections, driving employment and investment gains. Those products include building materials, furniture and heavy trucks.

“The past depreciation of the Canadian dollar has improved the price competitiveness of Canadian products,” the bank said. “Several categories of goods exports that are more sensitive to the exchange rate are showing positive momentum.”

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