Bank of Canada Sticks by Policy Rate Commitment

As was universally expected, the Bank of Canada left the overnight rate unchanged at 0.25% coming out of its policy-setting meeting today. What was open to more debate was what the central bank might say as to its earlier commitment to maintain this rate until the end of the second quarter of next year. Financial markets had started to price in a possible 25-basis point move as early as March next year. In today’s statement the central bank made clear that it was not budging from this conditional commitment. In so doing, the Bank of Canada may have been trying to take some of wind out of the sails of the Canadian dollar. In the statement released at the conclusion of the meeting, the Bank warned that “heightened volatility and persistent strength in the Canadian dollar are working to slow growth.”

In an additional comment about the C$, the central bank indicated that “the current strength in the dollar is expected, over time, to more than fully offset the favourable developments since July.” The “favourable developments” refers to a stronger-than-expected rebound in global growth relative to what was expected in the July Monetary Policy Report (MPR). In fact, the Bank opted to lower its GDP growth estimates slightly for both this year (-2.4% from -2.3%) and in 2011 (3.3% compared to 3.5%). The growth forecast for 2010 was left unchanged at 3%.

The slight downward revision to growth in this three-year period has resulted in a delay in the closing of the output gap (i.e., the difference between actual GDP and an estimate of potential GDP in which all inputs are fully utilized) by one quarter to the third quarter of 2011. Consistent with this projection, inflation’s return to the 2% mid-range target has been pushed out a quarter as well to the third quarter of 2011. The greater persistence of slack in the economy and attendant downward pressure on inflation provide more reason for the Bank of Canada to delay rather than advance any tightening in policy.

The statement characterizes the Canadian economy as one in which a recovery is under way. A return to economic growth is being supported by “monetary and fiscal stimulus, increased household wealth, improving financial conditions, higher commodity prices, and stronger business and consumer confidence.”

RBC Financial Group
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The statements and statistics contained herein have been prepared by the Economics Department of RBC Financial Group based on information from sources considered to be reliable. We make no representation or warranty, express or implied, as to its accuracy or completeness. This report is for the information of investors and business persons and does not constitute an offer to sell or a solicitation to buy securities.