Bank of Canada leaves rates unchanged - TD Economics

TD Economics

 Bank of Canada leaves rates unchanged, dovish tone maintained

• The Bank of Canada held its benchmark overnight rate at 1.00% today, as was widely expected. Its communiqué was broadly consistent with the diminished outlook seen in September’s interest rate announcement and silences any debate about rate cuts.
• The Bank reiterated that that several downside risks in the last MPR have been realized, and there has been a generalized retrenchment in risk-taking across global markets.
• It expects the euro area to experience a brief recession. Its base-case outlook also assumes the euro-area debt crisis will be contained, while acknowledging this outcome has significant downside risks.
• As for the U.S., the Bank expects weak real GDP growth through the first half of 2012, before strengthening thereafter, in line with our own forecast.
• Growth in emerging markets is expected to “moderate to a more sustainable pace”, and combined with recent declines in commodity prices are expected to “dampen global inflationary pressures”.
• The Bank did update its headline growth numbers that will be fleshed out in more detail in tomorrow’s Monetary Policy Report, stating that it now expects Canadian GDP growth to post a 2.1% pace in 2011, 1.9% in 2012, and 2.9% in 2013. That outlook is weaker than the last MPR in July, and is remarkably in line with our own forecast.
• The Bank predicts core inflation will be slightly softer than previously envisaged, implying it views the recent acceleration in core inflation as temporary.
• The Bank characterizes growth as having rebounded in Q3, but underlying momentum has slowed and is expected to remain modest through the middle of next year, as a less favourable external environment affects Canada through financial, confidence and trade channels. Domestic demand is expected to remain the principal driver of growth, although “modest” consumer spending and “solid” business investment are both expected to be more subdued than before.

Key Implications

• Today’s communiqué essentially reiterated the more dovish tone of September’s rate announcement. It is also consistent with our call for the Bank of Canada to leave interest rates unchanged until the first quarter of 2013.
• The Bank reminded markets that Canada has a target rate near historic lows, a well-functioning financial system and considerable monetary policy stimulus. This should quiet any talk of rate cuts, which markets had started to price in during the worst of the recent market turmoil. However, in removing any reference to the withdrawal of monetary stimulus, markets have initially interpreted the statement as more dovish.
• All told, today’s statement confirms our view that given the downgraded global growth outlook, and greater economic slack in the Canadian economy than previously expected, interest rates will need to remain accommodative for quite some time. Our Bank of Canada call implies a flat overnight rate for over two years – an unprecedented situation which underscores the fragility of the economic recovery.

Leslie Preston, Economist

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