After temporary growth spurt, Canadian economy is slowing, says Bank of Canada

OTTAWA – The Canadian economy likely expanded by a surprisingly strong 4.2 per cent in the first three months of the year, but it was a temporary burst of activity that is already over, the Bank of Canada says in its new outlook.

The central bank’s new quarterly outlook paints a picture of an economy that is settling down to a protracted period of slow growth, being held back by a high loonie, a tapped-out consumer and government spending restraint.

The bank says the current second quarter will see growth brake to two per cent, less than half what it was in the first, in part because of supply disruptions to Canada’s auto sector caused by the Japanese earthquake and tsunami. The disruption will lessen going forward, however.

On an annual basis, the economy is forecast to slow from 2.9 per cent this year, to 2.6 per cent next year and 2.1 per cent in 2013.

The overall take from the document is that the bank appears in no hurry to start raising interest rates to slow the economy because other factors are doing the job.

The bank doesn’t appear to be overly worried that high oil and food prices might trigger inflation. It briefly notes that inflation may hit three per cent, at the upper end of the bank’s acceptable range, in the next few months, but appears unconcerned.

“The combination of modest growth in labour compensation (wages) and higher productivity is expected to continue to dampen inflationary pressures, with the higher assumed value of the Canadian dollar providing further restraint,” the bank said.

Economists had been pointing to either May or July as the most likely dates for the bank to start raising its policy rate from the current one per cent, which would have the effect of also raising short-term interest rates for such things as variable mortgages.

But the dovish tone of the latest outlook suggests interest rates could remain low longer, especially amid fears that moving aggressively in advance of the United States likely would have the undesired effect of lifting the loonie even higher.

The bank does concede that it has been taken by surprise by the 3.3 per cent expansion in the fourth quarter of 2010, and the likely even stronger 4.2 per cent spurt in the first three months of this year.

That means Canada’s economy will likely return to full capacity by the middle of next year, earlier than previously expected.

But it stresses temporary factors were responsible, including stronger exports and domestic consumption, and that there is still plenty of slack in the economy.

The exports surge is already over, the bank says, and the persistently strong dollar averaging $1.03 US will continue to restrain exports going forward.

“The bank continues to project ... that the recovery in exports will be subdued relative to earlier global recoveries, with the higher level of the Canadian dollar assumed in this projection adding to long-standing competitive challenges,” it said.

Consumption may remain moderately stronger than would be assumed, the bank says, in part because high commodity prices are increasing household purchasing power through gains in the terms of trade, the difference between export and import prices. It estimates the country’s gross domestic income will rise by 4.7 this year.

Still, it believes the housing market will continue to cool and that government spending restraint will be a net drag on the economy this year.

The biggest engine of growth remains business investment, it says, in part because the higher Canadian dollar makes investment in foreign-made machinery and equipment less expensive.

Globally, the bank sees little change in the economic outlook, although it continues to stress risk factors such as high debt both among households and governments in the advanced economies, the Japanese crisis, turmoil in the Middle East and high commodity prices, especially oil.

Despite the risks, it says the global recovery is becoming more rooted and that even growth in troubled Europe is strengthening.

“The global economic recovery is projected to proceed at a steady pace over 2011-13,” the bank says, projecting growth of 4.1 per cent this year and 3.9 per cent next.

The bank has slightly lowered its forecast for U.S. growth this year to three per cent, from its previous 3.3 per cent call four months ago.