…And we are back after a bit of a hiatus! As part of our continued coverage on Central Bank sentiment and policy stance “post Lehman” till now, today we turn our attention to the Bank of Canada. Like her Southern neighbour, the Canadian economy faced the economic consequences of the sub-prime mortgage crisis, especially so with regards to lumber exports to the US housing sector and as the crisis gathered momentum, to its auto exports headed south of Lake Ontario. As the global and Canadian economic sentiment has improved, and the BoC’s key policy rate continues to be at 0.25% today compared with 3.00% in October 2008, the Central Bank is set for a protracted period of monetary policy inaction as far as the policy rate is concerned. Expect to see the rate at 0.25% well into the first half of 2010.

Bank of Canada: Monetary Policy Report

October 2008: The BoC’s MPR began by noting the following: “Three major interrelated global developments are having a profound impact on the Canadian economy and making the outlook more uncertain than it was at the time of the July Monetary Policy Report Update (July 2008).” First and foremost the BoC saw the intensification of the global financial crisis in the weeks leading up to the October 2008 MPR as a restrain on growth for some time to come. Secondly, it considered that the global economy was “heading into a mild recession”, which was expected to pick up only modestly through 2009. Thirdly, the sharp declines in commodity prices had reduced inflationary pressures globally and would do so in Canada as well. About domestic economic conditions, the Bank believed that Canadian growth would be sluggish through Q1 2009, pick up over the rest of 2009 and accelerate to above potential growth in 2010. However it added, “uncertainty around the Bank’s base-case projection for growth and inflation in Canada is much greater than normal…” The Bank saw downside risks to growth from weaker global demand and hence lower exports, and lower commodity prices which could deteriorate Canada’s terms of trade to moderate domestic demand growth. The Bank lowered its growth estimate for FY2008 from 2.3% to 0.6% and maintained the same for FY2009, with an improvement in growth to 3.4% in FY2010. Inflationary pressures were projected to ease significantly with core inflation expected to remain below 2% until the end of 2010. According to the Bank, core inflation was projected to decline from 1.8% in the fourth quarter of 2008 to 1.5% in mid-2009 was expected to return to 2% by the end of 2010, and headline inflation was projected to fall below 1% by mid-2009 before it would head back to the 2% target by the end of 2010. In light of diminished inflationary pressures, the Bank of Canada in concert with other major Central Banks lowered its overnight interest rate by 75bps in October to 2.25%. The Bank judged that “risks are roughly balanced around its revised base case projection for inflation in Canada - a base case that now incorporates the recent intensification of the global financial crisis, and a mild global recession. There will be downward pressure on core inflation coming from the presence of excess supply in the economy and modest reductions in housing prices.”

January 2009: The Bank of Canada in its January Monetary Policy Report considered the global economic outlook to have deteriorated significantly since the October Monetary Policy Report. It said, “the major advanced economies, including Canada, are now in recession, and emerging market countries are increasingly affected. Policy-makers have responded to the fall in global economic activity with bold and concerted policy actions. Central banks have cut monetary policy rates aggressively since last October, and governments in many countries are enacting substantial fiscal stimulus packages.” The BoC went on to say, “economic activity in all regions is expected to be much weaker over the next couple of years than projected in the October Report because of a more protracted and widespread weakness in global financial markets and a stronger negative feedback to the real economy.” In terms of the domestic outlook, the Bank expected economic output in Canada to decline through mid-2009 as a result of the global developments, recover in the second half of 2009, and to grow above potential in 2010. Real GDP growth according to the BoC was projected to drop 1.2% in 2009 and rebound by 3.8% in 2010. In the Bank’s assessment, the major downside risk to growth, came from the accelerated downturn in U.S. economic activity with direct consequences for Canadian exports (in terms of auto and lumber export declines). Along with a sharp drop in output, a decline in house prices posed further concern on the inflation front. Consequently, core inflation was projected to ease through 2009 and reach an anticipated low of 1.1% by Q4 2009, while headline inflation was expected to fall more abruptly and dip below zero in the second and third quarters of 2009 mostly on account of the base effect in energy prices. The BoC said that it expected headline and core inflation to return to the Bank’s 2% target rate in the first half of 2011 even as it revised down projections for headline inflation from its October MPR. The BoC clearly sounded guarded in its inflation risk assessment as it noted that, “global developments continue to pose significant risks to the Bank’s inflation projection for Canada, on both the upside and the downside.” The upside risk came from a stronger than expected recovery on the back of fiscal and monetary stimulus, while the downside risk persisted from a more protracted recession and longer than expected stabilization time in global financial markets. Against this background, the Bank lowered its policy rate by 50bps to 1.00% and brought the cumulative monetary policy easing to 350bps since December 2007, when the overnight rate was at 4.50%.

April 2009: “In an environment of continued high uncertainty, the global recession has intensified and become more synchronous since the Bank’s January Monetary Policy Report Update, with weaker-than-expected activity in all major economies…As a result, the recession in Canada will be deeper than anticipated, with the economy projected to contract by 3.0 per cent in 2009.” Thus began BoC’s April Monetary Policy Report. According to the Bank, the domestic economic recovery would be delayed until the fourth quarter and would be more gradual. Subsequent to that, the BoC estimated that economic activity would grow by 2.5% in 2010 and by 4.7 % in 2011, and reach its production capacity in Q3 2011. In terms of inflation, it expected core inflation to diminish through 2009, and gradually return to the 2% target in the third quarter of 2011. Headline inflation according to the Bank was expected to trough at -0.8% in Q3 2009 and return to target in Q3 2011. The Bank saw downside risks to inflation from a more protracted global recession than what was anticipated earlier and noted that, “more generally, there are risks around the resolution of global imbalances.” Consequently, the BoC lowered its policy rate by 25bps to 0.25%, and added that “conditional on the outlook for inflation, the target overnight rate can be expected to remain at its current level until the end of Q2 2010 in order to achieve the inflation target. The Bank will continue to provide guidance in its scheduled interest rate announcements as long as the overnight rate is at the effective lower bound.”

July 2009: In the July MPR, the BoC noted that “there are now increasing signs that economic activity has begun to expand in many countries in response to monetary and fiscal policy stimulus and measures to stabilize the global financial system. However, the recovery is nascent. The views expressed by the Bank in the April MPR with respect to the domestic economy were thought to be consistent with its outlook over the medium term. The BoC saw a gamut of conditions namely, stimulative monetary and fiscal policies; improved global financial conditions; firmer commodity prices; and a rebound in business and consumer confidence to have boosted domestic demand growth. The higher Canadian dollar, however, remained an area of concern. The Bank projected economic activity to contract by 2.3% in 2009, subsequently grow by 3.0% in 2010, and by 3.5% in 2011, reaching production capacity in the middle of 2011. On inflation, the BoC’s view held that headline inflation would trough by Q3 2009 before it would head back to the 2% target by Q2 2011, and core inflation would diminish in the second half of 2009 before it would gradually return to 2% in the second quarter of 2011. The Bank added that, “although the vigorous policy actions taken by monetary and fiscal authorities around the world appear to have reduced the probability of an extreme negative outcome for the global economy, significant upside and downside risks remain to the inflation projection for Canada.” And went on to reaffirm its conditional commitment to maintain its target for the overnight rate at the effective lower bound of 0.25% until the end of Q2 2010 in order to achieve the inflation target.