Bank of Canada cuts 2013 growth forecast, says economy performing ‘well below capacity’

OTTAWA—The Bank of Canada cut its 2013 growth forecast, saying it now thinks the economy won’t get back to full speed until mid-2015—about six months later than predicted earlier this year.

The central bank’s announcement suggests it will need to keep interest rates in Canada at historically low levels well into 2014, if not beyond.

As universally expected, the central bank kept its overnight trendsetting rate—which influences borrowing costs in the country—at one per cent, where it has been since September 2010.

Also expected, the bank did a full climb-down on its optimistic reading for the economy for this year by cutting the growth forecast to 1.5 per cent from 2.0, admitting the economy is performing well below capacity.

Some economists had advised Bank of Canada governor Mark Carney and his policy-setting team to drop the bank’s tightening bias, which signals the next action rate move will be up, not down.

“With continued slack in the Canadian economy, the muted outlook for inflation and the constructive evolution of imbalances in the household sector, the considerable monetary policy stimulus currently in place will likely remain appropriate for a period of time, after which some modest withdrawal will likely be required consistent with achieving the two per cent inflation target,” wrote Carney in a release.

The bank gives a hint as to why it did not go the next step in its analysis of the housing market. It judges the bias as one factor in the recent cooling trend in the real estate market and household borrowing—developments it views as desirable.

The bottom line is that the bank sees removing its warning about higher interest rates as risking renewed irresponsible consumer borrowing, which is already at record high levels with households owing 165 per cent their disposable annual incomes.

Still, markets are likely to read Wednesday’s policy statement and forecast change as more dovish and expect the current low interest rate to remain to late 2014 or even 2015.

At 1.5 per cent, the forecast is now below the 1.6 per cent private sector consensus used by Finance Minister Jim Flaherty in the March budget, the first time in a few years that the Canadian central bank has been below the consensus.

The reason, explained governor Carney and his team, is that the economy stalled in the second half of the year and weak demand from foreign markets and the high dollar will continue to restrain exports. As well, subdued housing demand will exert a drag on growth, as will government austerity. In truth, the bank says, not much in the economy is operating at full tilt.

The overall impact will be that the Canadian economy won’t return to full capacity until the second quarter of 2015, about the same time inflation will edge back to where the bank wants it, at about two per cent.

Still, the bank retains its sunny outlook that better days are ahead. When? The bank says Canadians can expect growth to accelerate to 2.5 per cent in the second half of this year after sub-two-per-cent growth in the first two quarters.

And it sees a bigger bounce in 2014, with an average cruising speed of 2.8 per cent, slightly better than it had anticipated in January. In 2015, when the economy has closed the capacity gap, growth will slow slightly to 2.7 per cent.