By Paul Vieira, Financial Post
OTTAWA — The recession is at an end, the Bank of Canada suggested Thursday, as improved credit markets and higher levels of consumer confidence are expected to generate positive growth this quarter.
The prediction, contained in the central bank’s quarterly monetary policy report, envisages economic growth of 1.3 per cent for the current quarter, ending Sept. 30, followed by a healthy three per cent gain for the final three months of 2009.
As a result of the bank’s outlook, the recession — the deepest since the Second World War — will have lasted three quarters. In its previous forecast in April, the Bank of Canada anticipated the economy shrinking one per cent in the current three-month period before growth returning in the fourth quarter.
“This somewhat more favourable short-term outlook reflects a more modest retrenchment in household and business spending, as negative effects on confidence dissipate, financial markets improve, and the terms of trade increase more quickly than previously anticipated,” the central bank said.
Meanwhile, the central bank also raised the spectre that inflation — which drives movement in its key policy rate — could move up quicker than anticipated if the recovery proves even stronger than expected.
Earlier this week, in its fixed-date rate announcement, the central bank had revised upward its forecast, saying the economy would contract this year less than expected, by 2.3 per cent, and grow three per cent in 2010, which is above the Bay Street consensus and double the anticipated growth of the United States, Canada’s biggest trading partner. The monetary policy report added details as to when growth is to begin and from what sectors of the economy.
Driving growth will be sharper improvements in consumer spending and housing sales for this year, compared to previous expectations. This can be attributed to consumers who believe the worst has subsided and are willing to spend — including the purchase of real estate — in order to take advantage of record-low borrowing costs.
Further, the central bank said conditions in the financial market have improved to a level above the 10-year norm, based on a gauge it uses.
“Overall, low borrowing costs for households and falling borrowing costs for businesses should help to revive interest-sensitive spending and support the economic recovery,” it said.
Despite the upward revisions, however, the central bank suggested household spending is expected to remain “cautious” for the remainder of this year and next in light of weak labour markets and equity portfolio losses. The savings rate, meanwhile, is expected to remain “elevated” for the next several years.
Meanwhile, the central bank acknowledged inflation — which drives where it sets interest rates — has come in higher than envisaged, as wages continued to increase despite weak productivity and excess supply “substantially” growing in the second quarter.
“(This) may also point to a sluggish response of inflation to excess supply,” the outlook said. “Nonetheless, the substantial excess supply in the economy is expected to result in lower core inflation over the next few quarters.”
The central bank said core inflation, which strips out volatile items such as energy, is set to drop from its current 1.9 per cent level to a low of 1.4 per cent in the fourth quarter, and return to its preferred two per cent target in the second quarter of 2011 (which is one quarter earlier than it forecast in April).
The central bank sets its key policy rate with the goal to achieve two per cent inflation. The key policy-lending rate is at 0.25 per cent, or as low as possible, in an effort to move inflation toward that two per cent target. The central bank has repeatedly pledged to keep the benchmark rate at that level until mid-2010.
In detailing risks to its outlook, the central bank noted there is a “possibility” that inflation could head higher because the economic recovery “will be stronger and more sustained” than what it anticipates.
“Measures of near-term inflation expectations have risen somewhat from very low levels in recent months, reflecting increases in commodity prices as well as improved market sentiment and consumer confidence.”
Still, it judged that the overall risks to its inflation projection remain tilted “slightly” to the downside. This is in part due to its finding that the economy operated about 3.5% below its potential in the second quarter. In addition, it added, companies face pressure to further reduce inventories in response to “exceptionally” high stock-to-sales ratios.