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Kitsilano Real Estate Update: BOC - economic outlook has changed

Today's Monetary Policy Report (MPR) fleshed in the details behind yesterday's statement by the Bank of Canada that the economic recovery is likely"to be more gradual than it had projected in its July Monetary Policy Report.” Specifically, Canadian growth this year and next were revised down to 3.0% and 2.3%, respectively, from previously-estimated 3.5% and 2.9%. Growth in 2012 was revised up to 2.6% from 2.2%. The central bank now expects the output gap to close by the end of 2012 rather than the end of 2011 to early 2012. The Bank estimates that the economy was operating at 1.75% below its potential as of the end of the third-quarter 2010.

Today’s MPR provides some additional details behind Canada's revised growth forecast looking at the quarterly pattern with slower growth rates forecasted across the board for 2010 and 2011, with the exception of the fourth quarter of next year. The updated forecasts show the economy growing at 1.6% in the third quarter, much slower than the July forecast of 2.8%. Fourth quarter growth is now expected at 2.6% from 3.2%. Similarly, the MPR indicates the central bank is now projecting the core inflation rate will be lower than it expected in July with the core rate forecasted at 1.6% in the second half of the year from 1.8% in the July forecast. This slower pace of increase is forecasted to persist throughout 2011 and 2012 with the rate hitting the 2% target in the final quarter of 2012. There were more minor changes to the forecast for headline inflation. The Bank deems that there is still considerable slack in the economy that will keep inflation contained going forward.

The details of the Bank's growth forecasts highlight a shift from consumer and government spending to business investment and net exports as supporting growth. The outlook for consumer spending is that it will grow at a pace that is closer to income growth. Additionally, spending will be dampened by "increasingly stretched" household balance sheets and the absence of support from rising housing prices going forward. The Bank also expects government spending will act as a mild negative for growth in 2011. On the upside, higher business investment and rising demand for Canadian exports should support the economy's expansion. 

The Bank of Canada provides updates on its outlook for potential growth once a year with the release of the October MPR. In the October 2009 MPR, the Bank projected potential growth of 1.5%, 1.9% and 1.9% for 2010 to 2012, respectively. This projection reflected an assumption of “trend” labour productivity growth of a measly 0.2% this year followed by gains of 0.9% and 1.2% in 2011 and 2012, respectively. In today’s MPR, the Bank revised its outlook for potential to 1.6% in 2010, 1.8% in 2011 and 2.0% in 2012. Potential is forecasted to rise to 2.1% in 2013. The revisions reflect an increase in labour productivity in 2010 to 0.6% and lower trend labour growth of 1.0% (from 1.3% in October last year). Labour productivity is forecasted to grind higher in 2011 until 2013 while labour input is expected to be more moderate than in 2010.

The report presents a weaker outlook for the global economy although the Bank expects that a modest recovery will continue. The forecast for the US was cut to 2.7% in 2010 (from 2.9%) and more substantially to 2.3% (from 3.0%) in 2011. Deleveraging by households, the persistently weak labour market and renewed weakening in the housing market are resulting in a more gradual recovery in domestic demand than the Bank assumed in July. The outlook for the world economy was upped in 2010 to 4.7% (from 4.6%) although this likely reflects strong growth in the first half of the year. 2011's global growth forecast was shaved to 3.5% from 3.8%. 2012 forecasts were lowered for all countries covered in the table, with the exception of China where the growth rate was boosted to 8.9% from 8.7%. Global growth in 2012 is now forecasted at 3.8%. The Bank highlights that for the global recovery to continue there needs to be a "greater rotation of demand" from public to private, which will be "supported by increased flexibility in exchange rates."

The Bank said that the risks to the outlook are "roughly balanced" pointing to the prospect of higher than forecasted commodity prices, stronger than expected housing and labour market developments in the US, or stronger than expected household borrowing and spending in Canada. The downside risks could arise from higher currency or slackening productivity performance that dampens the outlook for Canadian exports, intensification of global deflationary pressures or a sudden weakening in Canada's housing market. The Bank assumes that that Canadian dollar will average $0.98 against the U.S. dollar, energy prices will move along with futures pricing (oil prices were upped across the forecast compared to July) and global credit conditions will remain supportive.  

Given this forecast update, we maintain our call that the Bank of Canada will keep the overnight rate at 1% in the near term. Our baseline forecast that the economic recoveries in both the US and Canada will be solidly in place and that worries about sustainability will ease sufficiently by the March policy meeting, however, sets up for the Bank to resume gradually increasing the policy rate. With inflation quiescent, we look for a cumulative increase in the overnight rate of 125 basis points in 2011 to 2.25%.  


Dawn Desjardins, Assistant Chief Economist, RBC Economics

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