The Bank of Canada is leaving its key
interest rate unchanged, betting that a burst of federal infrastructure
spending and a global recovery will lift the Canadian economy out of its
funk.
Governor Stephen Poloz and his
central bank colleagues opted Wednesday not to cut the bank’s overnight
rate, now set at 0.5 per cent, in what analysts had predicted would be a
very close call.
Looking beyond the ongoing stock market
correction and a continued slide in the price of oil, the bank insisted
2016 will be a turnaround year for the economy.
“While
risks to the world outlook remain and have been reflected in sharp
price movements in a range of asset classes, global growth is expected
to trend upwards in 2016,” the bank said in a surprisingly upbeat statement.
The
bank insisted Canada’s wrenching pivot from a resource-driven economy
to one powered by other activities is “under way” and that the job
market remains “resilient” outside the resource sector.
But
the bank acknowledged that the economic environment remains “highly
uncertain.” And it once again slashed its growth forecast for 2016 – to
1.4 per cent from 2 per cent – and warned that more turmoil is in store
for the oil patch.
By not cutting
rates, Mr. Poloz may also want to avoid triggering an even sharper dive
in the Canadian dollar – one of the world’s weakest currencies in recent
months. Lower Canadian interest rates typically depress the currency as
investors seek better returns elsewhere, including the U.S., where the
Federal Reserve has begun to hike its own rates.
Most
analysts say a rate cut later this year remains a possibility. CIBC
World Markets economist Nick Exarhos said Mr. Poloz appears “willing to
wait and see what the Finance Minister [Bill Morneau] provides as a
bolster to the economy before pulling the trigger on any more monetary
easing.
The decision to not cut now
suggests the central bank was worried about knocking the dollar down
further and causing already debt-laded Canadians to borrow more, Bank of
Montreal chief economist Douglas Porter said.
The
cheaper dollar has also caused angst among many Canadians who now face
sharply higher prices for groceries and other imported goods, as well as
winter getaways to the U.S. Even exporters, who stand to benefit most
from a low dollar, had warned that a further drop would not be helpful.
The
dollar fell below the psychological threshold of 70 cents (U.S.) this
week, dragged lower by the dropping price of oil and anticipation of a
possible Bank of Canada rate cut.
Speaking
to reporters in Ottawa, Mr. Poloz acknowledged that the bank’s decision
not cut rates again was influenced by fears that a more pronounced drop
in the dollar could spur unwanted inflation plus the expected fiscal
stimulus coming from the federal government.
“The likelihood of further fiscal stimulus was an important consideration,” he said.
At
the same time, “another rapid depreciation” in the Canadian dollar
could send inflation sharply higher as imported goods become pricier, he
said.
“We need to be patient,” Mr. Poloz added.
The
bank pointed out that its latest forecast does not factor in the
“positive impact of fiscal measures expected in the next federal
budget.” The new Liberal government has promised to run deficits and
boost infrastructure spending by roughly $5-billion a year, but is under
pressure to do even more. The bank said the size and timing of this
stimulus won’t be known until the federal budget, expected in March.
Mr.
Poloz acknowledged that Canada’s economy suffered a “setback” in the
final three months of last year, but he dismissed this as a largely
temporary stall.
Some economists say
the economy may even have shrunk in the fourth quarter – in what would
be a third quarter of negative GDP in 2015.
Instead,
the bank estimates that gross domestic product grew a slim 0.3 per cent
in the fourth quarter and is poised to gather momentum as the year
progresses. The bank blamed the stall on weaker-than-expected U.S.
factory production, lower business investment at home and various
temporary factors, including a strike by Quebec public sector workers.
Growth is expected to rebound in 2017 to 2.4 per cent, or roughly in line with the bank’s previous forecast in October.
The
bank has also pushed back, once again, its estimate of when the
Canadian economy will return to full capacity – to “around the end of
2017” from mid-2017. This suggests the Bank of Canada could keep
interest rates at today’s low level for up to another two years, even as
the Federal Reserve ratchets up U.S. rates.
The
bank expects that the depressed price of oil will recover – at least in
the medium term. The price of crude has plummeted to near $30 a barrel
from more than $100 in the past two years.
“The
risks to oil prices are tilted to the upside,” the bank said in its
monetary policy report. “The significant reductions in oil investment
since late 2014 could leave future demand increases unmet, putting
upward pressure on prices and drawing investment back into the sector.”
The bank’s forecast, however, assumes that oil prices will stay “near their recent levels.”
The
bank is also warning that conditions could still get much worse in the
oil patch, where job losses and production cuts have already plunged the
province of Alberta into recession. “Low oil prices . . . will require
more fundamental changes to operations and could be more profound than
the already difficult adjustments made in 2015,” the bank said in its
monetary policy report.
The bank
pointed out, for example, that even at prices of $40-$50 a barrel (for
West Texas Intermediate crude) many industry executives say the “current
composition of the industry is unsustainable.”
Many
oil sands operations are “approaching break-even prices on a cash flow
basis,” which could trigger further cuts to production and investment it
said.
The bank says investments by
energy companies will fall 25 per cent this year, or even more sharply
than the 20 per cent drop it projected just three months ago. Investment
plunged 40 per cent last year.