Bank of Canada Tweaks Forecasts, Maintains Policy Stance

The Bank of Canada left the overnight rate at 0.25% and maintained its assessment of the risks to the outlook as being balanced based on macro considerations but "tilted slightly to the downside" because policy is operating at the effective lower bound. Once again, the central bank gave a conditional commitment to keep the policy rate at its current level "until the end of the second quarter of 2010" in order to ensure that inflation stays on course to meet the medium-term target.

The bank listed factors supporting economic growth and maintained its forecast that the economy will grow in both 2010 and 2011. It made modest changes to its annual growth forecasts with 2010 real GDP expected to increase by 2.9%, down from 3% in its October outlook, and 3.5% in 2011, up from 3.3%. On balance, this is a mild nudge up in its forecast to growth. The Bank highlighted that it expects that the "private sector should become the sole driver of domestic demand growth in 2011." The strengthening in Canada's currency and weak U.S. demand will act "as significant drags on economic activity in Canada."

The Bank provided a more upbeat assessment on the global outlook than its October statement and indicated that "somewhat stronger" growth forecasts will be included in its Monetary Policy Report to be released on Thursday. On inflation, the bank said that the core rate has been slightly higher than it projected, expects that the economy will return to full capacity and that the inflation rate will return to the 2% target in the third quarter of 2011.

The Bank maintained its forecast that stronger growth will likely be reported for the final quarter of 2009, after a disappointing third-quarter performance, with the economy forecasted to build momentum throughout 2010. Last week's Business Outlook survey that showed a solid pickup in planned investment in machinery and equipment, and an improving employment outlook, and this morning's report showing that the leading indicators index posted its largest one-month gain since 1983 all provide support to this view of stronger growth. The Bank, however, sees the strengthening in the Canadian dollar and weak U.S. demand as providing downside risks to Canada's recovery. On the other hand, risks that the Canadian domestic demand or the global economic recovery will prove stronger than current projections are acting to balance off these downside concerns about the outlook.

Today's reiteration that overall risks are "tilted slightly to the downside" as a result of policy operating at the lower bound indicates that the bank's policy plan remains intact and it is unlikely that there will be a change in the overnight rate before the end of the second quarter of this year. To be sure, a stronger-than-expected report on the fourth quarter and a round of outsized employment gains could change the timing of the first rate increase. Our forecast projects for Canada's economy to build momentum in the quarters ahead although we still project that 2010's annual growth rate will fall short of those recorded during the early stages of past recoveries, which will likely result in the Bank holding off raising the overnight rate until the summer. We expect the Bank to increase the overnight rate by 100 basis points in the second half of the year as it begins the process of adjusting monetary policy toward a more neutral stance.

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.