Jacqueline Thorpe, Financial Post Published: Thursday, July 17, 2008
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The Bank of Canada continues to expect Canada to escape a recession in the first half of 2008, and has slightly raised its projection for second quarter growth. The bank also downplayed the rise in inflation expectations among many Canadian businesses, saying they could reverse quickly if volatile energy prices stabilize.
The bank forecasts the economy to grow an annualized 0.8% in the second quarter, up from an earlier forecast of 0.3% in April. The economy contracted 0.3% in the first quarter. Two back-to-back quarters of negative growth are required to meet the widely accepted definition of a recession.
Businesses drew heavily on inventories in the first quarter after importing heavily at the end of 2007. This idled factory production and weighed heavily on growth but the bank believes this process has now been worked through and growth should bounce back in the second quarter.
Solid consumer spending and domestic demand will also support the economy, boosted by continued income gains from roaring commodity prices.
"Final domestic demand is projected to be the key driver of economic growth in Canada over the projection horizon," the bank said in Monetary Policy Report update. "Recent increases in commodity prices lead to higher wages and salaries, higher government revenues, higher corporate profits and equity valuations and stronger investment growth, particularly in the energy sector."
The bank sees growth of 1.3% in the third quarter and 1.8% in the fourth, both slightly lower than in the April monetary report.
As already reported in its interest announcement on Tuesday, growth for the year as whole is projected to be slower at just 1% compared with an earlier forecast of 1.4%. Total inflation is seen soaring to 4.1% by the end of the year.
The bank kept its target for overnight rates steady at 3% on Tuesday, saying the level remains "appropriate" against its projections and that the risks to its projections for inflation remained balanced.
The bank said strong growth in many emerging markets was the key force behind the recent surge in energy and food prices but added "overly accommodative monetary policies have fed domestic demand and further exacerbated inflation pressures in several emerging Asian economies."
At home, it downplayed the rise in inflation expectations in its recently released business outlook survey. In the survey, one-third of firms expected inflation to be above 3% for the next two years.
It said the measure was highly influenced by swings in energy prices and tends to reverse as total CPI inflation falls in response to stabilizing or declining energy prices.
It noted the mean private sector forecast for total CPI inflation in 2009 remains at 2% while inflation forecasts two years out have stayed at 2%.
While financial market measures of inflation forecasts have increased in recent months, "liquidity and technical factors suggest this measure should be interpreted with caution," the bank said.
"Considering all measures, the bank judges that expectations of inflation over the policy horizon remain well-anchored to the 2% inflation target," it said.
The bank said credit conditions in Canada remain "challenging" amid volatile markets but noted short-term credit spreads have narrowed significantly in recent months and overall borrowing costs having dropped by about 75 basis points over the past year, along with interest rate cuts.
Growth in business credit has slowed in recent quarters but household credit growth remains robust - a development the bank considered "somewhat surprising" given the moderating housing market and reported declines in consumer confidence.
It is clear the bank does not believe the jolt up in energy prices has crossed over into pain territory for many Canadians stressing throughout the report that the boost to incomes will be a major supportive factor for the economy.
Even while the economy contracted in the first quarter, real domestic income increased at an annual rate of 2.4% in the quarter, owing to a further 8.1% annualized improvement in Canada's terms of trade.
On a year-over-year basis this real income measure is up 4% due mainly to rising commodity prices
The bank has raised its projections for U,S. growth slightly for 2008 to 1.6% from 1.0% but lowered it to 1.5% for 2009 from 1.7%.
And world growth is expected slightly higher at 4.1% compared with an earlier forecast of 3.7%, leading to the curious situation where Canada, a global exporter, is expected to have weaker growth, due mainly to the big inventory drawdown in the first quarter.
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