TORONTO — Markets were prepared for the Bank of Canada to leave the overnight rate at 0.5 percent today; however, they were less certain about how the bank would characterize the financial outlook, RBC Economics reported.
Ever cautious, policymakers highlighted risks to the outlook and the persistence of economic slack although now expect output gap will close sooner than they did in January, said Dawn Desjardins, assistant chief economist.
The bank incorporated the string of recent strong reports into its near term forecast however remains reluctant to extrapolate this strengthening. Rather, the report highlights that temporary factors underpinned the uptick and concludes that it’s “too early” to say the economy will stay on this firmer growth trajectory.
The report aimed to balance the recent strengthening in growth and potential headwinds associated with shifting trade policies leading the governor to characterize the bank’s stance as “decidedly neutral.” As a result, RBC continues to expect the overnight rate will remain at 0.5 percent in 2017, said Desjardins.
Highlights of the report include:
- Material slack exists although the estimate of the output gap was 0.75 percent at the end of the first quarter, markedly below January’s 1.25 percent estimate for the end of 2016.
- The economy’s potential growth rate has been lowered to account for weak investment though is expected to gradually recover from 2017’s 1.3 percent estimate.
- Underlying inflation and wages remain subdued and the headline rate is projected to hold around the 2 percent target over forecast horizon.
- Economic growth has been stronger than anticipated but the composition uneven. More moderate gains are expected and the drivers of growth will transition and be more broadly based going forward. The key driver of the 2017 forecast upgrade was robust housing market activity in the first quarter.
- Given the uncertain outlook about shifts in trade policy, the bank’s projections incorporate “at least some of the adverse impact of elevated uncertainty” including a 0.2 percent cut to export growth and a 0.5 percent hit to investment in both 2017 and 2018.
“The Bank of Canada incorporated the string of recent strong reports into its near term forecast however remains reluctant to extrapolate this strengthening,” said Desjardins. “The bank pulled forward the absorption of current slack in the economy to the first half of next year.
“Today’s update shows growth running above potential in 2018 and 2019, implying the economy will shift into excess demand,” she explained. “However given the risk that external uncertainties and the attendant downward impact on growth will play out, there is little focus on this. Should these pressures fail to materialize, however, the current outlook implies policy will need to tighten.
“Today’s report aimed to balance the recent strengthening in growth and potential headwinds associated with shifting trade policies leading the governor to characterize the bank’s stance as “decidedly neutral.” As a result, we continue to expect the overnight rate will remain at 0.5 percent in 2017,” said Desjardins.
SOURCE: RBC Economics press release