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October 26, 2011

Bank of Canada maintains one percent target rate

On October 25, 2011, Canada's central bank once again kept its target for the overnight rate at 1.0%. The rate has remained the same since September 8, 2010, when it was increased by 0.25%.

Similar to the last announcement, on September 7, 2011, Bank of Canada governor Mark Carney stated that several of the downside risks highlighted in the Bank's July Monetary Policy Report (MPR) have been realized. The potential impact from deleveraging by financial institutions and consumers, recently announced austerity measures, and weakening confidence have been key causes for global investors becoming more risk averse and enduring increased volatility in capital markets.

Within the United States, growth expectations remain muted as consumer confidence has weakened, credit conditions have deteriorated, and announced austerity measures are expected to have a negative impact through the first half of next year. Outside of North America, the Bank of Canada noted that reconstruction efforts in Japan will provide a boost to the country's growth for both 2012 and 2013. Perhaps more importantly, the Bank believes that the euro area's economic difficulties will be contained; however, they are expected to encounter a brief recession.

Considering the Bank's last two announcements, it could be considered a surprise that the Bank made no mention of the potential for withdrawing any of the considerable monetary stimulus that is currently in place. After the Bank of Canada's announcement on July 19, 2011, sentiment amongst many economists suggested that an increase to the Canadian overnight lending rate by the end of the year was imminent. In September, however, the Bank's comments suggested a more negative tone as the perceived need to withdraw stimulus had diminished. Today's announcement, even more pessimistic, has led some economists to speculate that the next move for the Bank of Canada will be to add further monetary stimulus.

Gross domestic product (GDP)

In the announcement, Mark Carney said that a less favourable external environment, noted above, would have a negative impact on net exports, one of the two keys to a sustainable economic recovery. Further, the Canadian consumer is expected to remain as the key driver of growth; however, this will proceed at a slower pace as the wealth effect from lower asset valuation hinders confidence. Business spending, the other key to a sustainable economic recovery, is expected to maintain its recent strength, but may be reduced in an increasingly uncertain market environment.

In light of these expectations, the Bank has lowered its economic growth forecast for 2012 to 1.9% from 2.6% and increased its expectation for 2013 by 0.7% to 2.9%. Further, the Bank now expects the Canadian economy to return to full capacity by the end of 2013, a full 18 months later than what had been previously expected.

Inflation

Although the most recent core inflation data was above the Bank of Canada's target of 2.0%, Mr. Carney suggested that it will decline through next year and return to 2.0% by the end of 2013. Headline inflation projections were also lowered and total CPI inflation is now expected to fall to 1.0% by the middle of next year before moving up to the 2.0% target by the end of 2013. Similar to last month's announcement, elevated food and energy prices are seen as temporary factors and are expected to moderate further.

Canadian currency

The pessimistic tone in the Bank's statement had an immediate impact on the Canadian dollar. Prior to the announcement, the Canadian dollar was trading above par for the first time since September 21, 2011; however, by 11:12 a.m. the dollar had fallen to $0.98318 USD.

Next announcement

The next scheduled date for announcing the overnight rate target is December 6, 2011.

Bank of Canada press release