Economic recovery is "solidly entrenched": Bank of Canada

Paul Vieira, Financial Post

OTTAWA -- After months of uncertainty, the economic recovery now appears to be "solidly entrenched," the Bank of Canada said Tuesday, indicating its forecast for growth should unfold as envisaged.

Still, in its latest interest rate announcement, the central bank reiterated, as expected, its conditional commitment to keep its key policy rate at a record low 0.25% until June 2010 as inflation is still not expected to hit its preferred 2% target until the second half of 2011.

Recent data - from retail sales to a stunningly strong jobs report for November -- have painted a mostly cheer picture of the Canadian economy, analysts say, even though third-quarter GDP growth of 0.4% annualized came in well below the central bank's 2% expectation.

Since the central bank's latest economic forecast in October, "global economic developments have been slightly more positive and the global outlook has improved modestly," the bank's governing council said in its statement, adding though that "significant fragilities" remain.

The central bank said the composition of economic growth is unfolding as expected, highlighted by a shift toward stronger domestic demand and less reliance on exports.

"The main drivers and the profile of the projected recovery in Canada remain consistent with the bank's [outlook]," it added. "The bank continues to expect economic growth to become more solidly entrenched over the projection period and inflation to return to the 2% target in the second half of 2011."

According to the central bank's outlook, Canada is expected to grow 3.3% this quarter, followed by expansion of 3% next year and 3.3% in 2011. Predictions for strong growth gained steam late last week when data indicated the Canadian economy added 79,000 jobs in November.

Further, the central bank on Tuesday played down the impact of the stronger dollar, even though it acknowledged it remained a key risk to its forecast, and "could act as a significant further drag" on growth and inflation. The stronger loonie, which has advanced as much as 25% this year against its U.S. counterpart, led to a surge in imports in the third quarter - resulting in net exports acting as a drag on the economy of roughly 5.3 percentage points.

Since the last rate announcement, however, the dollar has on average traded a couple of cents below the central bank's working assumption of a US96¢ loonie.

Most analysts were looking for any change in nuance in the bank's statement - in particular a hint or two that it might move before its conditional pledge to keep rates at a record low until June 2010 given the surge in domestic consumption as households take advantage of record low borrowing costs.

Instead, the central bank reiterated that its target rate of 0.25% "can be expected" to remain intact until the end of the second quarter of next year. The pledge is conditional on inflation hitting the 2% target in the third quarter of 2011, as the bank expects.

The last time the bank raised its key policy rate, to 4.5%, was in July of 2007 - and shortly afterward the first signs of the credit crisis emerged.

Some economists, such as Ryan Brecht of Action Economics, expect the central bank to begin hiking its policy rate, and aggressively, starting in the second half of next year.

In a note released Tuesday morning, Mr. Brecht, the firm's senior North American economist, said he envisaged the Bank of Canada raising its target rate by 175 basis points before December of 2010, for a policy rate of 2%, or "more normal levels." Still, that would be below the 3% level in September of 2008, when Lehman Bros. collapsed, or the 4.5% peak hit more than two years ago.