The Bank of Canada is adopting a neutral stance on the direction of interest rates over the next few years, signalling that it may be as prepared to cut the cost of borrowing as it is to raise the cost, in light of persistently low inflation and a weaker forecast for economic growth through 2015.
As expected, the central bank announced Wednesday it is keeping the overnight rate, which impacts short-term interest rates, at one percent, where it’s been for more than three years.
But removal of the central bank’s so-called tightening bias—in place since April 2012—suggests at the very least that it’s even less anxious to raise interest rates than a few months ago.
The Canadian dollar, which had already been down against the U.S. dollar before the announcement, dipped even further after the Bank of Canada statement. The loonie fell 0.89 of a cent to 96.3 cents US Wednesday after having gone as low as 96.18 cents US.
Markets are likely to see the statement as an indication that bank governor Stephen Poloz will likely keep the trendsetting policy interest rate at one percent well into 2015.
The reason, the bank says in its latest monetary policy report, also released Wednesday, is that the economy is still not ready to transition from a reliance on domestic demand to export-driven growth capable of getting reluctant Canadian firms to start investing and hiring.
“In Canada, uncertain global and domestic economic conditions are delaying the pickup in exports and business investment, leaving the level of economic activity lower than the bank had been expecting,” Poloz and his governing council stated in the summary of the report.
“As a result, the current level of economic activity is now estimated to be lower than was anticipated in the July report.”
In fact, the bank appears to have fundamentally rewritten its playbook for the economy from a few months ago.
It has shaved this year’s growth projection by two-tenths of a point to 1.6 percent, which would make the third consecutive year that the pace of economic expansion has slowed. It has revised downward even more dramatically next year’s forecast, by four-tenths of a point to 2.3 percent, and for 2015 by one-tenth to 2.6 percent.
In July, the bank had forecast growth rates of 1.8, 2.7, and 2.7 for the three years.
As well, the bank says the economy is about 0.4 percent smaller than it had previously calculated, has more unused capacity, and will take longer by about six months to return to full capacity, now projected for the end of 2015.
For many economists, the bank’s new, darker tone puts it in the camp they’ve occupied for most of the year.
They have long considered the bank’s growth forecasts too rosy and have been less enthusiastic about the so-called “rotation” from domestic to external demand—particularly given the fiscal games being played by Republicans and Democrats in the U.S. Congress since the end of 2012.
The bank is optimistic the damaging spate of recent U.S. government shutdowns, automatic spending cuts, and threats of default are coming to an end, which should restart the U.S. expansion and hike demand for Canadian exports.
“The U.S. economy is softer than expected, but as fiscal headwinds dissipate and household deleveraging ends, growth should accelerate through 2014 and 2015,” the bank predicts.
But it admits to some worries as to how much this will help Canada in the short term.
Weak demand partly explains the difficulty Canadian exporters have been experiencing of late, it says, but not all, adding that the under-performance “may be due to shifts in trade linkages that have been difficult to properly capture and to ongoing competitiveness challenges.”
It is possible, the bank says, that competitive pressures due to the high dollar and poor productivity will result in an even greater loss of market share for Canada’s exporting sector than assumed.
The bank concludes that there are still many risks to the global and Canadian outlook.
With files from The Canadian Press