The Bank of Canada (BOC), which surprised markets in January by cutting its rate by 25 basis points, slashed its forecast for economic growth this year and said it expects the economy to have contracted in the first half of 2015 due to lower investments in the energy sector and weaker-than-expected exports of non-energy commodities and non-commodities.
"Additional monetary stimulus is required at this time to help return the economy to full capacity and inflation sustainably to target," the BOC said, attributing the fall in prices of some of its key commodity exports to slow growth in the United States and China.
The BOC, which has now cut its key rate by 50 basis points this year, projects that Canada's Gross Domestic Product will grow by just over 1.0 percent in 2015 - down from its April forecast of 1.9 percent - and then by about 2.5 percent in 2016 and in 2017 when it expects the economy to return to full capacity and inflation to reach 2 percent.
Last week the International Monetary Fund also cut its forecast for Canada's growth this year to 1.5 percent, down from its Spring forecast of 2.2 percent while the 2016 forecast was raised to 2.1 percent from a previous 2.0 percent.
Annual growth in GDP is forecast to be 1.1 percent in the second quarter of this year, a downward revision from April's forecast of 1.9 percent and then fall further to 0.7 percent in both the third and fourth quarters of this year, a downward revision from April's forecast of 1.8 percent in both quarters.
In the first quarter of this year, Canada's GDP grew by 2.06 percent, down from 2.63 percent in the fourth quarter of last year. Quarter-on-quarter, the BOC sees second quarter GDP contracting by 0.5 percent, a sharp revision of its previous forecast for expansion of 1.8 percent.
The drop in the Canadian dollar over the last 12 months will help its exporters and the BOC said recent evidence suggested a pickup in activity and rising capacity among those exporters that are most sensitive to the value of the Canadian dollar.
The Canadian dollar, known as the loonie, fell in response to the central bank's rate cut, hitting 1.295 to the U.S. dollar from yesterday's 1.276 to be 10 percent below the beginning of this year.
The lower prospects for Canadian growth has increased the downside risks to inflation, but the BOC largely maintained its forecast for inflation.
By the fourth quarter of this year, consumer price inflation is forecast at 1.4 percent, unchanged from April's forecast, and then 1.9 percent in the fourth quarter of 2016, slightly below its previous 2.0 percent forecast. By the fourth quarter of 2017 inflation is seen unchanged at 2.0 percent, meeting the BOC's target.
The Bank of Canada issued the following statement:
"The Bank of Canada today announced that it is lowering its target for the overnight rate by one-quarter of one percentage point to 1/2 per cent. The Bank Rate is correspondingly 3/4 per cent and the deposit rate is 1/4 per cent.
Total CPI inflation in Canada has been around 1 per cent in recent months, reflecting year-over-year price declines for consumer energy products. Core inflation has been close to 2 per cent, with disinflationary pressures from economic slack being offset by transitory effects of the past depreciation of the Canadian dollar and some sector-specific factors. Setting aside these transitory effects, the Bank judges that the underlying trend in inflation is about 1.5 to 1.7 per cent.
Global growth faltered in early 2015, principally in the United States and China. Recent indicators suggest a rebound in the U.S. economy in the second half of this year, and growth is expected to be solid through the projection. In contrast, China is slowing amid an ongoing process of rebalancing to a more sustainable growth path. This has pulled down prices of certain commodities that are important to Canada’s exports. Financial conditions in major economies remain very accommodative and continue to provide much-needed support to economic activity. Global growth is expected to strengthen over the second half of 2015, averaging about 3 per cent for the year, and accelerate to around 3 1/2 per cent in 2016 and 2017.
The Bank’s estimate of growth in Canada in 2015 has been marked down considerably from its April projection. The downward revision reflects further downgrades of business investment plans in the energy sector, as well as weaker-than-expected exports of non-energy commodities and non-commodities. Real GDP is now projected to have contracted modestly in the first half of the year, resulting in higher excess capacity and additional downward pressure on inflation.
The Bank expects growth to resume in the third quarter and begin to exceed potential again in the fourth quarter, led by the non-resource sectors of Canada’s economy. Outside the energy-producing regions, consumer confidence remains high and labour markets continue to improve. This will support consumption, which will also receive a fiscal boost. Recent evidence suggests a pickup in activity and rising capacity pressures among manufacturers, particularly those exporters that are most sensitive to movements in the Canadian dollar. Financial conditions for households and businesses remain very stimulative.
The Bank now projects Canada’s real GDP will grow by just over 1 per cent in 2015 and about 2 1/2 per cent in 2016 and 2017. With this revised growth profile, the output gap is significantly larger than was expected in April, and closes somewhat later. The Bank anticipates that the economy will return to full capacity and inflation to 2 per cent on a sustained basis in the first half of 2017.
The lower outlook for Canadian growth has increased the downside risks to inflation. While vulnerabilities associated with household imbalances remain elevated and could edge higher, Canada’s economy is undergoing a significant and complex adjustment. Additional monetary stimulus is required at this time to help return the economy to full capacity and inflation sustainably to target."
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