OTTAWA – The Bank of Canada is taking a more positive view of the Canadian economy, while doubling down on warnings over household debt, the strong dollar and now the price of oil.
Building on Tuesday’s policy rate announcement that predicted 2.4 per cent annual growth this year and next, the central bank’s quarterly monetary policy review provided a generally positive spin on Canada’s economic outlook — particularly in the first half of this year.
The central bank said growth in the first three months of the year will likely be a relatively robust 2.5 per cent annualized, well above the 1.8 level it had expected in its January report.
The second and third quarters will be similarly stronger than previously thought, it said, allowing the economy to return to full capacity for the first time since the recession by the first half of 2013 — as much as six months earlier than anticipated. Then the expansion will moderate, but remain positive.
“The economy has some momentum,” bank governor Mark Carney told reporters following release of the monetary policy report.
The quicker closing of economic slack is consistent with Carney’s signal on Tuesday that he may be preparing to hike interest rates sooner than many believed, perhaps as early as the fall, analysts said.
“The growth forecast presented by the bank would certainly justify some upward move in rates over the coming year or so,” said CIBC chief economist Avery Shenfeld.
He cautioned, however, that only a minor setback would be needed to stay Carney’s hand.
“For now, however, the market is likely to continue to brace itself for rising rates in Canada, putting upward pressure on short-term bond yields and providing support for the Canadian dollar.”
Carney told a news conference Wednesday that when and if he raises interest rates will depend on how the economy performs, noting that there are still plenty of pitfalls to avoid.
Externally, Europe’s debt crisis has stabilized but is far from resolved.
In Canada, he expressed concern with the high level of household indebtedness, currently at a near record 151 per cent of disposable income.
The bank report contained a special section on debt, particularly Canadians borrowing on home equity lines of credit (HELOCs) and mortgage financing to fuel consumption in discretionary goods. HELOC and refinancing credit has grown from about $8 billion in 2001 to $64 billion in 2010 as home prices have risen, with about half of that “equity extraction” going into consumption or to pay off other debt.
“There is a possibility, with potential developments in the housing markets, that there will be a bigger impact on consumption if house prices were to move downwards,” Carney said.
“It’s the biggest domestic risk.”
But he made clear that was not why he has moved up the needle on future interest rate hikes, saying the primary reasons are better economic performance and stronger inflationary pressures.
“Monetary policy is not the first line of defence (for debt accumulation), it’s not the second or third. It’s the last line of defence,” he said, pointing out that lending rules are being tightened and that federal Finance Minister Jim Flaherty has responsibility for limiting mortgage eligibility.
Carney also put a number on the economic cost of recent oil price increases. While normally higher prices are a benefit to Canada, a net exporter of crude, under the current circumstances Canada is losing about 0.1 percentage points from economic growth.
That’s because Canadian producers are exporting crude at well below global oil prices. About half of Canada’s gasoline supply comes from imports of Brent crude, which has been above US$120 a barrel, while producers in Western Canada have realizing about US$80 a barrel.
While the bank expects the price gap to narrow somewhat, it won’t close significantly until Canada builds more pipeline capacity.
“These prices are much higher than the prices our major producers are receiving … it’s a very large spread,” Carney said. “(The impact on economic growth) is marginal, but it’s a marginal negative as opposed to a positive, so it’s a swing that’s material.”
Still, Carney noted even with the unexpected drag from oil, he expects the economy to register above trend growth this year and in 2013.
The above parity Canadian dollar is also exerting a drag on activity, Carney said, particularly exporters who must sell their goods in the United States. But keeping interest rates artificially low is not the answer, he added, saying what is needed is more business investment to improve productivity and competitiveness.
On Canada’s labour market, the bank suggested that concern by business about labour shortages in Canada are a myth, at least for most of the country.
It notes that both the employment and unemployment rate remain unchanged from their levels six months ago and that the proportion of “involuntary part-time workers” has only partially recovered “pointing to the persistence of unused capacity in the labour market.”