The Bank of Canada has left the key overnight interest rate unchanged at 1%, but has also signaled the days of super-low borrowing costs will soon come to an end. The Bank Rate is correspondingly 1.25% and the deposit rate is 0.75%.
Overall, the profile for global economic growth has improved since the Bank released its January Monetary Policy Report (MPR), with Europe expected to emerge slowly from recession in late 2012. U.S. growth is slightly stronger, reflecting the balance of improved labour markets, financial conditions and confidence, as well as emerging fiscal consolidation.
Economic activity in emerging-market economies is expected to moderate to a still-robust pace over the projection horizon, supported by an easing of macroeconomic policies. Commodity prices are elevated due to positive economic prospects. However, the international price of oil has risen further and if sustained, could dampen the improvement in economic momentum.
Economic momentum in Canada is slightly firmer than the Bank had expected in January. The Bank expects economic growth of 2.4% this year, which is well above their January forecast of 2%, and expects next year’s expansion to be more moderate at 2.2%. The external headwinds facing Canada have abated, allowing for stronger growth prospects, and business and household confidence are improving.
The Bank projects that private domestic demand will account for almost all of Canada’s economic growth over the projection horizon. Household spending is expected to remain high relative to GDP as households add to their debt burden, which remains the biggest domestic risk. Business investment is projected to remain robust, reflecting solid balance sheets, very favourable credit conditions, continuing strong terms of trade and heightened competitive pressures.
The contribution of government spending to growth is expected to be quite modest over the projection horizon, in line with recent federal and provincial budgets. In addition, the recovery in net exports is likely to remain weak in light of modest external demand and ongoing competitiveness challenges, including the persistent strength of the Canadian dollar.
For the first time since the onset of the recession, the Bank forsees the global economy returning to full capacity in the first half of next year—one or two quarters ahead of its expected pace. In light of this reduced slack, the Bank says modest withdrawal of very stimulative interest rates is possible in the near future.
The next policy setting is June 5 but no hint has been given as to whether moves will occur so early. The bank has kept interest rates at the current level since September 2010. The Federal Reserve, as well as the banks in Australia, Europe, England, Mexico and Sweden will also be meeting in June to discuss economic issues and key rates.
In the opinion of Desjardins economists, many economic uncertainties will likely persist and force Canada’s monetary authorities to stay on the sidelines for several quarters. They have stated, “In a context where U.S. key rates will likely stay the same until at least 2014, it is hard to picture an early rise in Canada’s key rates,” with the possibility that the loonie and international merchandise trade will be negatively effected.