Economic Momentum is Cooling

In a rare event, both Bank of Canada Governor Mark Carney and Finance Minister Jim Flaherty were called to testify on the state of the Canadian economy in front of the Commons Finance Committee this morning. The meeting was called because policymakers are concerned over recent market turbulence, and weak global economic data. Recessionary fears have reared their ugly head once again.

Indeed, as pointed out by both policymakers today, Canadian economic growth is headed for a slowdown. A bout of weak domestic and international spending suggests that Canadian real GDP posted no growth in the second quarter. In fact, this week’s release of June real manufacturing (-1.6%) and wholesale trade (-0.7%) increases the risk that it could easily dip into negative territory. The economic data heading into the third quarter have been equally disappointing. Softening consumer confidence appears to be weighing on household purchases of big-ticket items.

And, this was all before the recent market gyrations in August. In view of recent events, Governor Mark Carney suggested that the Bank of Canada will downgrade their economic outlook somewhat, but is confident that economic growth will accelerate in the second half of 2011. Nonetheless, the number of international headwinds outlined in July’s monetary policy are starting to “blow harder”.

Today’s testimony also provided the two policymakers an opportunity to comment on what policy actions will be needed to support the economy. Both the Bank of Canada Governor, and Finance Minister highlighted that recent market turmoil is being driven by a loss in confidence in the ability of advanced economies to manage their government debt. As such, fiscal responsibility among governments (and households) is very important at this time. Minister Flaherty indicated that they are likely to stay the course with the 2011 budget plan which aims to balance the books by fiscal 2014-15. However, should a recession strike they would take measures to support jobs and the business sector.

Meanwhile, Governor Mark Carney’s testimony did not reveal a significant shift in monetary policy either. The Governor’s comments certainly were slightly more dovish than the communiqué in July when the Bank stated that monetary stimulus would start to be withdrawn conditional on an improvement in economic growth and the easing of international risks. At the same time he was not dovish enough to suggest that the Bank will resort to rate cuts, as is currently being priced into markets. The Governor stated that the course of monetary policy will change only if the inflation and growth outlook were to change materially. We take this to mean that the Bank of Canada may be on hold longer than markets were anticipating back in July, but a rate cut is not likely.

Overall, Governor Mark Carney’s comments do not alter our view on the future course of monetary policy. As outlined in this month’s issue of Global Markets – released on Wednesday – we are of the view that the growing number of economic and financial risks, in combination with our expectations for Canadian economic growth to remain sub- 2.0% for the remainder of 2011, will keep the central bank on the sidelines until July of 2012. Because many of the international risks are medium-term in nature, and economic growth is expected to remain modest through 2013 we expect a very gradual pace of monetary tightening thereafter. We forecast for the overnight rate to reach 2.00% by the end of 2012, and 3.00% by the end of 2013. In other words, expect interest rates to remain low for an extended period of time.

source: Diana Petramala