September 18, 2013 / 4:34 PM / in 4 years

Upbeat Bank of Canada says economy at tipping point

Bank of Canada Governor Stephen Poloz arrives at a news conference upon the release of the Monetary Policy Report in Ottawa July 17, 2013. REUTERS/Chris Wattie

VANCOUVER (Reuters) - Bank of Canada Governor Stephen Poloz took a notably upbeat tone on Wednesday, predicting the Canadian economy is about to enter a new phase of growth powered by business investment and exports as the U.S. recovery takes hold.

“Evidence suggests we are now close to the tipping point from improving confidence into expanding capacity,” he said in a speech to the Vancouver Board of Trade.

Speaking just before the U.S. Federal Reserve had been expected to announce a modest reduction in its bond-purchasing program, Poloz said there was evidence “we are on our way home” to economic growth that is self-sustaining rather than relying on low interest rates.

The Fed, however, announced on Wednesday that it was maintaining its stimulus program in full for the time being.

The Bank of Canada has held its key rate at 1 percent since September 2010. Analysts surveyed by Reuters expect the bank to keep it at that level until the fourth quarter of 2014, when they predict the bank will raise rates.

The speech provided no obvious hints on the timing of the next rate hike, and while the tone was confidence-building, the underlying message was that a tightening of monetary policy is still a long way off.

Using what he called a “spaghetti-sauce model,” Poloz referred to the global financial crisis as a seven-year bubble followed by a seven-year crater, implying the return to normal might not come until 2015.

“Though Poloz has presented a more optimistic view of the economy than was presented in the (Bank of Canada‘s) September 4 communiqué, today’s speech reinforces the wider narrative that policy will need to remain accommodative for a prolonged period of time to nurture the recovery,” TD Securities economist Mazen Issa said.

In another clue that Poloz may be in no rush to raise rates, he predicted Canada’s potential growth rate - the speed at which the economy can grow without fueling inflation - would increase from the current 2.1 percent as businesses invest more and expand capacity.

“The message here is that the economy should be able to support stronger activity without stoking inflation as investment ticks upward,” Poloz said.

The combination of subdued inflation and increased capacity could lessen the need to raise rates. Poloz said it was difficult to predict how quickly this higher growth potential would come about.

He also made it clear he does not see a housing bubble in Canada, saying tighter mortgage lending rules have engineered a “soft landing”. The household debt-to-income ratio will decline, he said, despite an uptick to a record high in the second quarter.

“I’ve said before and I’ll say again, I don’t perceive there is a bubble in Canada’s housing market,” he said. “We were more concerned about that a year ago, but things have calmed noticeably and credit itself has slowed.”

IMPACT OF FED TAPERING

Derek Holt, vice president of Scotiabank Economics, said Poloz might be setting the stage to keep rates on hold until mid-2015 to avoid getting too far ahead of the U.S. Fed in tightening policy.

“The way in which the output gap is laid out nicely coincides with the targeted Fed funds policy hold laid out by the Federal Reserve,” Holt said in a note to clients.

In a nod to the strengthening of the U.S. economy over the past year, the Fed had been expected to announce on Wednesday a modest reduction in its stimulative $85 billion per month bond-buying program. Instead, it said it would continue buying bonds at the current pace for now, surprising financial markets.

Poloz denied that Canadian monetary policy takes direction from U.S. policy. While the two economies are tightly linked, he said, “that does not mean that monetary policies need to mimic each other, and as you can see, we’ve had a substantially different monetary policy in Canada compared to the United States.”

Asked after the speech where he saw the value of the Canadian dollar after the economy’s return to normal, Poloz said: “The truth is, I have no idea ... the markets always get the dollar right.”

Writing by Louise Egan and David Ljunggren; Editing by Peter Galloway, Lisa Von Ahn and Jeffrey Hodgson

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