Economic slack in Canada and risks of overheating in the US

by Paul-André Pinsonnault, National Bank, Economics and Strategy

As widely expected, the Bank of Canada left the overnight rate unchanged at 0.50% today. The press release did not include an assessment of the balance of risk around the inflation outlook. Still the Bank’s Governing Council judged that the current policy stance remains appropriate.

Already in October the Bank pointed out the heightened uncertainty around its economic projections. This time around, the Bank referred to the “uncertainty, which has been undermining business confidence and dampening investment in Canada’s major trading partners”, saying that it remains undiminished.

The Bank made reference to the higher bond yields which it saw partly reflecting expectations of fiscal stimulus in the U.S.

Keeping a dovish tone, while acknowledging the strong growth in Q3, the Bank said it is expecting more moderate growth in Q4. It also pointed out that economic slack remains in Canada while the United States is near full capacity, a hint the Bank does not have to move in step with the FOMC. Moreover, echoing the concerns expressed in October regarding Canada’s exports, the Bank mentioned this time that non-energy goods exports continue to disappoint. The same assessment was also made as far as business investments were concerned.

Turning to the inflation outlook, it was mentioned that the effect of past exchange rate depreciation on core inflation is dissipating while the Bank expects persistent economic slack to put downward pressure on inflation.

Bottom line:

By dropping the balance of risk assessment from the press release, the Bank is indicating that the uncertainty around the economic outlook is larger than usual at a time when it is unclear how things will evolve south of the border. Fiscal expansion in the US might be coming at a time when the economy is operating near full capacity. This is adding uncertainty to the inflation outlook. In that context, the Bank is in fact leaving its options open, after having said in October that it had actively discussed the possibility of adding more monetary stimulus. So the Bank is in a wait and see mode, however it is doubtful that by January 18, when the Bank will present its economic update, that the US situation will be much clearer.

Paul-André Pinsonnault
National Bank, Economics and Strategy

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