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BoC downgrades Canadian economy, keeps stimulative 1% interest rate in place

OTTAWA - The Bank of Canada says the economy is not doing as well as expected and will likely need stimulative monetary policy to stay in place for longer than previously thought to create the conditions for a sustainable recovery.

In a mostly dovish monetary policy report, the bank's governing council kept in place Wednesday the one per cent trendsetting interest rate that is responsible for some of the lowest borrowing costs in memory. The rate has remained unchanged for almost four years.

But it is the downgrading of expectations for the economy that is likely to catch the markets' attention.

The bank cut its April projections for global growth this year by four-tenths of a point to 2.9 per cent and for the U.S. — Canada's most important foreign market — by more than a full point to 1.6 per cent.

The effect on Canada was less dramatic, but still significant. Economic growth projections for 2014 and 2015 were trimmed by one-tenth of a point — to 2.2 and 2.4 per cent respectively.

As well, the bank set further back to mid-2016 the target date for the economy to return to full capacity, suggesting that whatever timeframe markets had for the next interest rate hike, it is likely now to occur three months later.

The key reasons for the downgrade, said the bank, is that the world and particularly U.S. had an "abrupt slowing" at the start of this year — the American economy actually shrank by an eye-popping 2.9 per cent — and while growth has resumed, the bounce-back is not sufficient to make up for what has been lost.

For Canada, that will further delay the expected pickup in exports and business investment the bank had been counting on to put economy on a sustainable growth path.

"Consequently, the economy is expected to reach full capacity around mid-2016, a little later than anticipated in April," the bank said.

"Closing the output gap over the time frame described above is reliant on continued stimulative monetary policy and hinges critically on stronger exports and business investment."

Another key change from April is that Bank of Canada governor Stephen Poloz does not appear to be as worried about the risk of super-low inflation, acknowledging that consumers prices have risen faster and higher than it anticipated.

But the bank remains convinced that the recent pick-up to 2.3 per cent, slightly above target, is driven by temporary factors, specifically a bump in oil prices, pass-through from the stronger loonie, and heightened competition within Canada's retail sector.

Its forecast for inflation to hover around two per cent for the next two and a half years, and for core underlying inflationary pressures to remain below the two per cent target until 2016.

While the bank remains upbeat about the future, it is forthcoming about the soft spots in the Canadian economic landscape, particularly on the jobs front.

It points out that the economy has only managed to eke out about 6,000 jobs a month over the past year, but that the record is actually worse than even that modest number suggests. If not for tens of thousands of Canadians dropping out of the work force, the unemployment rate would be higher than the current 7.1 per cent.

There are about 100,000 fewer people in the prime 25-54 years work-age currently employed or looking for work today than there were six months ago, the bank noted.

"Continuing labour market slack is also reflected in subdued increases in wages," it added.

The outlook for exports and business investment, which the bank sees as connected, is also not strong, it said.

"The recovery in exports over the projection horizon will continue to be drawn out," it said. "The expected strong growth in energy exports and the return of growth to non-energy exports (such as manufacturing) will not be sufficient to fill the shortfall left by the weak performance of non-energy exports relative to foreign activity since the end of 2011.

One positive in the bank's report is that it expects Canada's housing market to ease toward a soft landing, and that household finances will stabilize. However, it still warns households remain vulnerable to adverse shocks due to the current high level of debt and elevated home prices.

The Canadian Press

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