Bank of Canada Monetary Policy Report - April 2012

8/2/2019 Bank of Canada Monetary Policy Report - April 2012

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Moetary Policy ReportApril 2012


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The Monetary Policy Report is available on the Bank of Canadas website at bankofcanada.ca.

For urther inormation, contact:

Publication Information

Communications Department

Bank o Canada

234 Wellington StreetOttawa, Ontario K1A 0G9

Telephone: 613 782-8111;1 800 303-1282 (toll ree in North America)Email: [email protected] Website: bankocanada.ca

ISSN 1201-8783 (Print)

ISSN 1490-1234 (Online)

2012 Bank of Canada

Canadas Inflation-Control Strategy1

Infation targeting and the economy

The Bas madate is to coduct moetary policy to pro-

mote the ecoomic ad acial well-beig o Caadias

Caadas experiece with iatio targetig sice 1991has show that the best way to oster codece i the

value o moey ad to cotribute to sustaied ecoomic

growth, employmet gais ad improved livig stadards

is by eepig iatio low, stable ad predictable

I 2011, the Govermet ad the Ba o Caada reewed

Caadas iatio-cotrol target or a urther ve-year

period, edig 31 December 2016 The target, as measured

by the total cosumer price idex (CPI), remais at the

2 per cet midpoit o the cotrol rage o 1 to 3 per cet

The monetary policy instrument

The Ba carries out moetary policy through chagesi the target overight rate o iterest2 These chages

are trasmitted to the ecoomy through their iuece

o maret iterest rates, domestic asset prices ad the

exchage rate, which afect total demad or Caadia

goods ad services The balace betwee this demad ad

the ecoomys productio capacity is, over time, the pri-

mary determiat o iatio pressures i the ecoomy

Moetary policy actios tae timeusually rom six to

eight quartersto wor their way through the ecoomy

ad have their ull efect o iatio For this reaso,

moetary policy must be orward looig

Cosistet with its commitmet to clear, trasparet

commuicatios, the Ba regularly reports its perspec-

tive o the orces at wor o the ecoomy ad their

implicatios or iatio The Monetary Policy Report

(MPR)is a ey elemet o this approach Policy decisios

are typically aouced o eight pre-set days durig the

year, ad ull updates o the Bas outloo, icludig

riss to the projectio, are published our times per year

i the MPR

Infation targeting is symmetric and flexible

Caadas iatio-targetig approach is symmetric, which

meas that the Ba is equally cocered about iatio

risig above or allig below the 2 per cet target

Caadas iatio-targetig ramewor is flexible

Typically, the Ba sees to retur iatio to target over

a horizo o six to eight quarters However, the most

appropriate horizo or returig iatio to target will

vary depedig o the ature ad persistece o the

shocs bufetig the ecoomy

Monitoring infation

I the short ru, a good deal o movemet i the CPI is

caused by uctuatios i the prices o certai volatile

compoets (eg, ruit ad gasolie) ad by chages i

idirect taxes For this reaso, the Ba also moitors a

set o core iatio measures, most importatly the

CPIX, which strips out eight o the most volatile CPI com-

poets ad the efect o idirect taxes o the remaiig

compoets These core measures allow the Ba to

loo through temporary price movemets ad ocus o

the uderlyig tred o iatio I this sese, core ia-tio is moitored as a operational guide to help the Ba

achieve the total CPI iatio target It is ot a replace-

met or it

1 See Joint Statement of the Government of Canada and the Bank of Canada on the Renewal of the Inflation-Control Target (8 november 2011) ad

Renewal of the Inflation-Control Target: Background InformationNovember 2011 , which are both available o the Bas website

2 Whe iterest rates are at the zero lower boud, additioal moetary easig to achieve the iatio target ca be provided through three ucove-

tioal istrumets: (i) a conditional statemet o the uture path o the policy rate; (ii) quatitative easig; ad (iii) credit easig These istrumets

ad the priciples guidig their use are described i the Aex to the April 2009 Monetary Policy Report


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Mor Poc RporApril 2012

This is a report o the Governing Council o the Bank o Canada:Mark Carney, Ti Macklem, John Murray, Timothy Lane, Jean Boivin and Agathe Ct.

This report includes data received up to 13 April 2012.


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The Bank will take whatever action is appropriate to achieve the 2 percent CPI ination target over the medium term. This is our contribution

to ensuring that Canadians can save and invest with confdence.

Over the next ew years, Canadian businesses will also have to analyse

and act. Their decisions to reocus, retool and retrain will do much to

determine how rapidly our prosperity grows in the decades ahead.

Mark Carney

Governor, Bank o Canada

2 April 2012

Waterloo, Ontario


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CoOverview 1

Global Economy 3

Global Fiacial Coditios 4

Euro Area 7

Uited States 8

Japa 11

Emergig-Maret Ecoomies 11

Commodity Prices 12

Implicatios or the Caadia Ecoomy 14

Caadia Dollar 15

Box 1: Risig Oil Prices ad Their Impact o the Caadia Ecoomy 16

Canadian Economy 19

Fiacial Coditios 19

Estimated Pressures o Capacity 22

The Real Ecoomy 23

Box 2: The Savigs Rate, Housig Wealth ad Debt 27

Iatio 30

Risks to the Outlook 35


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Or

The profle or global economic growth has improved since January. Europeis expected to emerge slowly rom recession in the second hal o 2012,although the risks around this outlook remain high. The profle or U.S. growthis slightly stronger, reecting the balance o somewhat improved labourmarkets, fnancial conditions and confdence on the one hand, and emerg-

ing fscal consolidation and ongoing household deleveraging on the other.Economic activity in emerging-market economies is expected to moderateto a still-robust pace over the projection horizon, supported by an easing omacroeconomic policies. Improved global economic prospects, supply dis-ruptions and geopolitical risks have kept commodity prices elevated. In par-ticular, the international price o oil has risen urther and is now considerablyhigher than that received by Canadian producers. I sustained, these oil pricedevelopments could dampen the improvement in economic momentum.

Overall, economic momentum in Canada is slightly frmer than the Bankhad expected in January. The external headwinds acing Canada haveabated somewhat, with the U.S. recovery more resilient and fnancial con-ditions more supportive than previously anticipated. As a result, business

and household confdence are improving aster than orecast in January.The Bank projects that private domestic demand will account or almostall o Canadas economic growth over the projection horizon. Householdspending is expected to remain high relative to GDP as households addto their debt burden, which remains the biggest domestic risk. Businessinvestment is projected to remain robust, reecting solid balance sheets,very avourable credit conditions, continuing strong terms o trade andheightened competitive pressures. The contribution o government spendingto growth is expected to be quite modest over the projection horizon, in linewith recent ederal and provincial budgets. The recovery in net exports islikely to remain weak in light o modest external demand and ongoing com-petitiveness challenges, including the persistent strength o the Canadiandollar.

The Bank projects that the economy will grow by 2.4 per cent in both 2012and 2013 beore moderating to 2.2 per cent in 2014. The degree o eco-nomic slack has been somewhat smaller than the Bank had anticipated inJanuary, and the economy is now expected to return to ull capacity in thefrst hal o 2013.

As a result o this reduced slack and higher gasoline prices, the profle orination is expected to be somewhat frmer than anticipated in January.

Ater moderating this quarter, total CPI ination is expected, along with coreination, to be around 2 per cent over the balance o the projection horizonas the economy reaches its production potential, the growth o labour com-pensation remains moderate and ination expectations stay well anchored.

OveRview 1BAnk OF CAnADA Monetary Policy rePort aPril 2012


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Despite recent improvements to the outlook or the global and Canadianeconomies, risks remain elevated.

The three main upside risks to ination in Canada relate to the possibility ohigher-than-expected oil prices, stronger-than-expected growth in the U.S.economy and stronger momentum in Canadian household spending.

The two main downside risks to ination in Canada relate to a reintensifcationo sovereign debt and banking concerns in Europe, and the possibility thatgrowth in Canadian household spending could be weaker than projected.

Overall, the Bank judges that the risks to the ination outlook in Canada areroughly balanced over the projection period.

Reecting all o these actors, on 17 April, the Bank maintained the target orthe overnight rate at 1 per cent. In light o the reduced slack in the economyand frmer underlying ination, some modest withdrawal o the presentconsiderable monetary policy stimulus may become appropriate, consistentwith achieving the 2 per cent ination target over the medium term. Thetiming and degree o any such withdrawal will be weighed careully against

domestic and global economic developments.

2 OveRviewBAnk OF CAnADA Monetary Policy rePort aPril 2012


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Go ecoom

Recent developments point to a somewhat stronger profle or global eco-nomic growth than was expected at the time o the last Report (Table 1).The heightened uncertainty around the global outlook has eased rom veryhigh levels, but volatility can be expected to persist. Economic conditions inthe United States have improved, and policy initiatives to address the sover-

eign debt and banking crisis in the euro area have resulted in some improve-ment in European debt markets and global fnancial conditions.

Table 1: Projection or global economic growth

Share o real globalGDPa (per cent)

Projected growth (per cent)b

2011 2012 2013 2014

United States 20 1.7 (1.8) 2.3 (2.0) 2.5 (2.2) 3.6

Euro area 15 1.5 (1.5) -0.6 (-1.0) 0.8 (0.9) 1.4

Japan 6 -0.7 (-0.8) 1.9 (1.9) 1.6 (1.7) 1.6

China 14 9.2 (9.1) 8.1 (8.2) 8.0 (8.0) 8.0

Rest o the world 46 4.3 (4.2) 3.4 (3.1) 3.5 (3.2) 3.7

World 100 3.8 (3.7) 3.2 (2.9) 3.4 (3.3) 3.8

a. GDP shares are based on International Monetary Fund (IMF) estimates o the purchasing-power-parity(PPP) valuation o country GDPs or 2010. Source: IMF, World Economic Outlook, September 2011

b. Numbers in parentheses are projections used or the January 2012 Monetary Policy Report.

Source: Bank o Canada

The global economy continues to ace signifcant challenges, however.Overall, global economic growth is projected to moderate in 2012 to 3.2 percent and to recover to 3.4 per cent in 2013 and 3.8 per cent in 2014.1Despite the positive impact o recent policy initiatives, the euro area is stillexpected to experience a recession lasting until the third quarter o 2012,ollowed by a sluggish recovery, with fscal austerity, bank deleveraging andweak confdence continuing to weigh on growth. The U.S. economic expan-

sion is projected to continue at a moderate pace through 2014, owing to therestraining eects o household deleveraging, fscal consolidation and con-tinuing negative spillover eects rom the European crisis. Economic activityin emerging-market economies is expected to moderate over the projectionhorizon, albeit to a still-robust pace, supported by some easing in macro-economic policies. Improved prospects or global economic growth andsupply-side disruptions have kept global commodity prices elevated, par-ticularly or crude oil, where prices also incorporate a geopolitical risk pre-mium related to tensions in the Middle East. This is expected to have a slightdampening eect on global economic momentum.

1 As is customary in the April issue o theMonetary Policy Report, the projection horizon has been

extended by one year, in this case, to 2014.

Recent developments point to

a somewhat stronger prole or

global economic growth

The global economy continues

to ace signicant challenges,

however

GlObal eCOnOMy 3BAnk OF CAnADA Monetary Policy rePort aPril 2012


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In response to modest underlying ination pressures, central banks inadvanced economies have maintained policy rates at historically low levels(Chart 1), and a ew have engaged in urther quantitative easing. Centralbanks in a number o emerging-market economies have continued toreverse past policy tightening in light o slowing prospects or domesticeconomic growth.

Global Financial ConditionsConditions in global fnancial markets have improved, on balance, since therelease o the January Report. The measures taken in Europe to address thesovereign debt and bank unding crisis, as well as stronger growth pros-pects in the United States, have led to an improvement in market sentimentover this period. The tone in markets was also boosted by the U.S. stresstests, which showed that the largest U.S. banks would retain sufcient cap-ital to withstand an extremely adverse macroeconomic scenario. Morerecently, however, concerns about the sovereign debt positions o someeuro-area peripheral economies, especially Spain, have reintensifed, andinvestor confdence has diminished somewhat.

European policy-makers have taken a number o initiatives over the pastyear to improve fnancial stability and confdence. They have agreed on asecond fnancial program or Greece in conjunction with substantial privatesector debt relie, raised the requirement or core Tier 1 capital ratios orbanks, adopted a new Fiscal Compact and increased the fnancial back-stop or euro-area members rom 500 billion to 700 billion. 2 In addition,the European Central Bank (ECB) has provided approximately 1 trillionin liquidity to banks in the region through two longer-term refnancing

2 The combined lending capacity o the European Financial Stability Facility and the European Stability

Mechanism (ESM) is 700 billion, o which 500 billion represents the permanent lending capacity o

the ESM. The remaining 200 billion consists o existing commitments to Greece, Ireland and Por tugal.

Conditions in global nancial

markets have improved, on

balance

Note: On 5 October 2010, the Bank o Japan changed the target or its policy rate rom 0.1 per cent to a range

o 0.0 to 0.1 per cent. The U.S. Federal Reserve has been maintaining a target range or its policy rate o

0.0 to 0.25 per cent since 16 December 2008.

Sources: Bank o Canada, U.S. Federal Reserve,

European Central Bank and Bank o Japan Last observation: 13 April 2012

Canada United States Euro area Japan

2008 2009 2010 2011 2012

%%

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Chart 1: Central banks in advanced economies have maintained policy

interest rates at historically low levels

Policy interest rates, daily data

4 GlObal eCOnOMyBAnk OF CAnADA Monetary Policy rePort aPril 2012


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operations and loosened collateral requirements.3 As a result, unding con-

ditions or European fnancial institutions have improved (Chart 2). With theexception o Spain, yields on euro-area government bonds have allen, withsovereign spreads over German bonds declining (Chart 3). Taken together,these developments suggest that the near-term risk o a severe bankliquidity crisis in the euro area has decreased.

Government bond yields in most major advanced economies have uctu-ated noticeably since the release o the January Report. Following an initialrise in reaction to improved prospects or global economic growth, yields

3 The longer-term refnancing operations were conducted in December 2011 and February 2012. The net

liquidity injection amounted to around 500 billion ater taking into account the existing borrowing rom

the European Central Bank that was rolled out o short-term operations such as the main refnancing

operations with a maturity o one week.

Source: Bloomberg Last observation: 13 April 2012

Canada United States Euro area United Kingdom

2009 2010 2011 20120

25

50

75

100

125

150

175

Basis points

January Report

Chart 2: Funding conditions or European banks have improved

since the lastReport

Spreads between 3-month interbank borrowing rates

and 3-month overnight index swaps, daily data

Note: Owing to data limitations, yields on 9-year sovereign bonds are used or Ireland.


Germany France Italy Spain Portugal Ireland

0

2

4

6

8

10

12

14

16

18

2009 2010 2011 2012

%

January Report

Chart 3: With the exception o Spain, yields on euro-area government

bonds have allen since the JanuaryReport

Yields on 10-year sovereign bonds, daily data



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have reversed most o their gains, owing to the deterioration in market senti-ment in the past ew weeks (Chart 4). In particular, German bond yields haveallen to record lows. Equity prices have allen modestly in Europe since thelast Report, reecting renewed concerns over the debt situation, but haveimproved in most other economies. Global corporate bond spreads havenarrowed, particularly or fnancial and high-yield issuers, and yields on U.S.investment-grade corporate bonds recently touched all-time lows. In thisshiting environment, corporate bond issuance has recovered strongly sincethe beginning o the year, with both fnancial and non-fnancial frms takingadvantage o better access to primary markets (Chart 5).

Despite the generally improved tone in fnancial markets since January,banks in the euro area have continued to tighten borrowing conditions orhouseholds and frms (Chart 6). Developments in Europe have also had

Corporate bond issuance has

recovered strongly


Canada United States Germany Japan United Kingdom

2009 2010 2011 2012

%

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5January Report

Chart 4: Government bond yields in most major advanced economies are

relatively unchanged rom the lastReport

Yields on 10-year sovereign bonds, daily data

Source: Bloomberg Last observation: March 2012

High-yield bonds (let scale) Investment-grade bonds (right scale)

0

20

40

60

80

100

120

140

160

0

10

20

30

40

50

2011 2012

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar

US$ billionsUS$ billions

Chart 5: Corporate bond issuance has recovered strongly since

the beginning o the year

Global corporate issuance placed in U.S. dollars, monthly data



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an impact on bank lending conditions in the United States. Foreign banksoperating in the United States have tightened approval standards on loansto U.S. corporations, while both U.S. and oreign banks tightened conditionson loans to banks headquartered in Europe and to non-fnancial frms withsignifcant exposures to European economies.

While the ECBs expanded liquidity operations have not by themselvesdirectly improved the underlying health o bank balance sheets, they have

created space or the restructuring o these balance sheets to proceed atan orderly pace. Pressures on unding conditions rom bank deleveraging inthe euro area are thus expected to persist, but to be less intense than antici-pated at the time o the January Report.

Euro AreaThe euro area entered a recession in the ourth quarter o 2011, with realGDP contracting by 1.2 per cent, as expected. However, recent economicconditions have improved slightly. Business and consumer confdence haverecovered modestly, and purchasing managers indexes suggest that thepace o output contraction is likely to ease somewhat in the frst hal o 2012.

The divergences in economic conditions between the core and peripheraleuro-area economies are striking. The unemployment rate in Germanyremains close to post-unifcation record lows, while unemployment rates inSpain, Portugal and Greece are at record highs (Chart 7). Indicators such asunit labour costs suggest that the peripheral economies have made limitedprogress in narrowing their competitiveness gap with the core economies.In light o continued economic weakness, some peripheral economies aceconsiderable challenges in implementing the extensive fscal adjustmentsand deep structural reorms required to restore competitiveness and ensuresustainable fscal positions.

The euro area entered a

recession in the ourth quarter

o 2011, which is projected

to continue through the third

quarter o 2012

Note: Data reect responses to the euro-area Bank Lending Survey. Actual tightening reers to the

tightening that has already occurred, while expected tightening reers to the additional tightening antici-

pated by banks.

Source: European Central Bank Last observation: 2011Q4

Actual tightening Expected tightening

2010 2011 2010 2011 2010 2 011 2010 2 011 2010 2 011

-10

0

10

20

30

40

50

%

Factors contributing to credit tightening

Costs related

to banks

capital

positions

Access

to market

fnancing

Banks

liquidity

positions

Expectations

regarding

general

economic

activity

Chart 6: Banks in the euro area have continued to tighten borrowing

conditions since the lastReport

Net percentages o banks contributing to credit tightening or enterprises



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The euro area is projected to be in recession through the third quarter o2012 as fscal consolidation, bank deleveraging, tight fnancial conditionsand negative confdence eects lead to a signifcant drop in domesticdemand. A modest recovery in economic activity is projected to begin in thesecond hal o 2012, supported by a pickup in export growth in response toa gradual strengthening in external demand. Domestic demand is projectedto grow modestly beginning in 2013, boosted by a gradual easing in fnan-cial conditions and an improvement in confdence. Relative to the JanuaryReport, the ongoing recession is expected to be somewhat shallower, owingto smaller-than-anticipated negative eects rom both bank deleveraging

and weak confdence levels. Growth prospects over the remainder o theprojection horizon, however, are similar to expectations in January.

Increases in commodity prices and a rise in indirect taxes and administeredprices rom fscal consolidation brought total ination in the euro area to2.6 per cent in March. Ination pressures are expected to moderate over theprojection horizon, however, in response to considerable excess capacity.

United StatesU.S. real GDP grew by close to 2.5 per cent in the second hal o 2011, romless than 1 per cent over the frst hal o the year, and recent economicdevelopments have been largely positive. On average, monthly employment

gains have strengthened since the ourth quarter o 2011, and consumer andbusiness confdence have shown more resilience than expected. Theassessment o the undamentals or household spending is now stronger,owing to upward revisions to personal income over the second hal o 2011,while the recent increase in equity prices has boosted household net worth.The spillover eects o the euro-area crisis on U.S. fnancial conditions andconfdence are likely to be smaller than expected. As a result, the profle orU.S. economic growth is stronger over the projection horizon than wasanticipated in the last Report, despite the negative eects o higher oilprices.

U.S. consumer and business

condence have shown more

resilience than expected

Source: Eurostat Last observations: January and February 2012

Germany Spain Portugal Greece Italy France

2007 2008 2009 2010 2011 2012

0

5

10

15

20

25

%

Chart 7: Striking divergences are apparent between the unemployment

rates o core and peripheral economies in the euro area

Unemployment rates, monthly data



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Notwithstanding this stronger outlook, U.S. real GDP is projected to grow ata relatively modest pace through the frst hal o 2013, dampened by fscalconsolidation and continued household deleveraging (Chart 8). Economicactivity is expected to strengthen more noticeably thereater as the impacto these actors dissipates. On balance, growth in real GDP is projected to

rise rom 2.3 per cent in 2012, to 2.5 per cent in 2013 and 3.6 per cent in2014.

Monetary conditions are expected to remain very accommodative: the U.S.Federal Reserve recently extended, through to at least late 2014, its guid-ance regarding the period during which economic conditions are likely towarrant exceptionally low levels o the ederal unds rate.4 In contrast, fscalconsolidation is expected to exert a signifcant drag on U.S. economicgrowth, amounting to roughly 1 percentage point in 2012, 2.5 percentagepoints in 2013 and one-hal percentage point in 2014, similar to expectationsat the time o the January Report (Chart 9). This projected fscal dragincludes the winding down o stimulus programs introduced during therecession, the expiration o payroll tax reductions at the end o 2012 and

sequestration cuts starting in 2013. The projected increase in U.S. real GDPgrowth between 2013 and 2014 is highly contingent on the expected profleor fscal policy.5

4 The U.S. Federal Reserve has also adopted an explicit ination target o 2 per cent, as measured by the

annual change in the price index or personal consumption expenditures.

5 Policy-makers in the United States could decide to adopt policies that would reduce the projected size

o the fscal drag in 2013. This could be achieved by postponing some or most o the sequestration cuts

that are currently expected to take place during that year. The stronger economic growth in 2013 that

would result rom these actions could be at the expense o growth in 2014, however (depending on the

revised timing o the cuts).

U.S. real GDP is projected to

grow at a relatively modest pace

Fiscal consolidation is expected

to exert a signicant drag on

U.S. economic growth

Note: The Big Five modern fnancial crises, as described in Reinhart and Rogo (2008), are Spain (1977),

Norway (1987), Finland (1991), Sweden (1991) and Japan (1992). See C.M. Reinhart and K.S. Rogo, Is

the 2007 U.S. Sub-Prime Financial Crisis So Dierent? An International Historical Comparison, American

Economic Review: Papers and Proceedings 98, no. 2 (2008): 33944.

Sources: U.S. Bureau o Economic Analysis, Organisation or Economic Co-operation and Development,

and Bank o Canada projections

U.S. current cycleBase-case projection The Big Five modern fnancial crisesRange o past U.S. recessions (1948 onward)

-2 -1 0 1 2 3 4 5 6 7

90

100

110

120

130

140

Index

Start o the recession

Years beore

the start o

the recession

Years ater

the start o

the recession

Chart 8: U.S. real GDP growth is projected to remain relatively modest

compared with previous U.S. recoveries

U.S. real GDP across economic cycles; start o recession = 100, quarterly data



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The recovery in consumption spending is projected to remain quite modestby historical standards as households rebuild their balance sheets in an

environment o persistently weak housing prices, fscal consolidation,modest gains in employment and elevated oil prices.

Residential investment remains very weak. Recent growth partly reects anincrease in the construction o apartment buildings, as high unemploymentand tight mortgage credit conditions have led to a shit in demand away romhome ownership toward renting (Chart 10). The inventory o vacant housesand the pending supply o oreclosures remain near recent record-high levelsand are restricting the construction o new homes, as well as puttingdownward pressure on house prices. High vacancy rates and tight creditconditions have also been restraining the growth o non-residential construc-tion. Both residential and non-residential construction are projected to remain

Residential investment remains

very weak

Source: U.S. Census Bureau Last observation: February 2012

Multiple-amily housing starts Single-amily housing starts

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Thousands of units

0

400

800

1,200

1,600

2,000

2,400

Chart 10: U.S. housing starts remain at a low level

U.S. housing starts, monthly data

Note: The contribution o fscal policy to growth includes both direct government expenditures and the

indirect eects on other components o aggregate demand. The estimated contribution over history has

been reassessed in light o additional inormation on U.S. government spending.

Sources: U.S. Bureau o Economic Analysis and Bank o Canada calculations and projections

GDP growth excluding

fscal policy

Estimated contribution rom fscal policy GDP growth

2011 2012 2013 2014

-3

-2

-1

0

1

2

3

4

5

%

Chart 9: Fiscal consolidation is expected to exert a signifcant drag

on U.S. real GDP growth

Annual data



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at low levels, although some gradual improvement is expected over the pro-jection horizon, supported by the reduction in the overhang o unsold houses,a gradual easing in borrowing conditions and a stronger economy.

Exports and business investment in equipment and sotware are expectedto provide important support to U.S. economic growth over the projection

horizon. Notwithstanding the dampening eects rom low rates o resourceutilization, business investment is projected to grow at a healthy pacethrough 2014, supported by solid corporate balance sheets, strong earningsand the low cost o capital. Although the growth o exports is expected toslow somewhat in 2012, owing to the recent appreciation o the U.S. dollarand a deceleration in oreign demand, it should rebound over 201314 asglobal demand recovers.

Given the modest pace o U.S. economic growth, excess supply conditionsare expected to recede only gradually over the projection horizon. As aresult, underlying ination pressures are projected to remain subdued.

JapanIn Japan, real GDP ell by 0.7 per cent in the ourth quarter o 2011 assupply-chain disruptions rom the ooding in Thailand, as well as the highlevel o the yen and altering external demand, caused a sharp declinein exports. With rapid restoration o these supply chains, indicators sug-gest that growth in Japan resumed at a modestly positive pace in the frstquarter o 2012. Over the projection horizon, real GDP growth is projected toaverage around 1.7 per cent per year, supported by the continued rebuildingo inrastructure. Although exports are expected to grow only modestly in2012, they are projected to gather momentum beginning in 2013, as globaldemand rebounds. With ination well below the recently announced goalo 1 per cent, the Bank o Japan decided to increase the size o its AssetPurchase Program by 10 trillion, or about 2 per cent o GDP, through gov-

ernment bond purchases.

Emerging-Market EconomiesReal GDP growth in China in the frst quarter moderated to 8.1 per cent on ayear-over-year basis, as a result o lower external demand and the eects oprevious tightening in monetary and macroprudential policies. Activity in thehousing sector has slowed, causing house prices to retreat rom the recentpeak reached in August 2011 (Chart 11). Growth in exports has deceleratedmore abruptly, in response to weaker demand rom Europe, which accountsor around one-fth o Chinese exports (Chart 12). Consumer price inationin China stood at 3.6 per cent in March 2012, well below its recent peako 6.5 per cent in July 2011, owing in large part to rapidly moderating ood

price ination. With ination pressures easing, monetary policy is becomingmore accommodative. Chinese authorities have reduced the reserverequirement ratio by 100 basis points since December, and urther easing isexpected.

Growth in Chinas real GDP is projected to average approximately 8 per centper year through 2014, similar to expectations at the time o the JanuaryReport. A modest appreciation o Chinas real exchange rate and the gov-ernments announced plan to boost household spending are expected tosupport a gradual rotation o demand away rom exports and investmentand toward consumption. Nevertheless, global imbalances remain a con-cern and are projected to stay elevated over the projection horizon.

Exports and business

investment are expected to

provide important support toU.S. economic growth

Growth in Chinas real GDP

is projected to average

approximately 8 per cent

per year through 2014



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19/42

activity, have combined to push Brent crude oil prices above the levels antici-pated at the time o the January Report. Prices or West Texas Intermediate(WTI) crude oil, in contrast, are little changed compared with their levels at thetime o the January Report, owing to abundant supply conditions in the U.S.Midwest. As a result, the spread between Brent and WTI crude oil prices has

widened to approximately US$20 per barrel. Based on the latest uturescurve, prices or both Brent and WTI are projected to remain frm in the nearterm, declining thereater in response to the normalization o global supplyconditions (Chart 13). Oil prices are projected to be higher than expected atthe time o the last Report, consistent with a more optimistic assessment odemand prospects.

North American prices or natural gas have allen, as cuts in production haveailed to oset the impact o unseasonably warm weather. The latest uturescurve suggests that natural gas prices will rise through 2014 as natural gasgains market share as an input or the generation o electricity, but pricesare nevertheless projected to remain at relatively low levels, below the pro-fle anticipated in the January Report (Chart 14).

Prices o non-energy commodities have increased over the past ewmonths, supported by improved global demand, as well as supply concernsin agricultural markets. While prices or agricultural products are expectedto decline over the projection horizon as supply conditions improve, pricesor orestry products are projected to rise gradually, in line with a modestrecovery in the U.S. housing sector. Metals prices are expected to remain atcurrent levels until the end o 2013, beore rising in 2014 owing to strongerglobal economic growth.

Oil prices are projected to be

higher than expected at the time

o the last Report

Spot price or WTI crude oil (13 April 2012)

Front-month utures or Brent crude oil (13 April 2012)

Based on an average o utures contracts over the two weeks ending 13 April 2012

Note: Values or crude oil prices in April 2012 are estimates based on the average daily spot prices up

to 13 April 2012. For Brent crude oil prices, ront-month utures prices are used.


Brent crude oil

Brent utures price

Brent utures price(January Report)

WTI crude oil

WTI utures price

WTI utures price(January Report)

2009 2010 2011 2012 2013 201430

50

70

90

110

130

US$/Barrel

Chart 13: Oil prices are expected to stay at elevated levels

Monthly data



20/42

Implications or the Canadian EconomyExternal demand or Canadas exports remains weak. The oreign activitymeasure has recovered only hal o the decline experienced during the lastrecession, owing largely to protracted weakness in the U.S. housing sector.This measure is expected to steadily expand over the projection horizon, asthe composition o external demand becomes more avourable to Canadian

exports, surpassing its pre-recession level in the second hal o 2013. Theprojected profle o the activity measure is somewhat stronger than wasanticipated in the January Report, in line with the upward revision to the U.S.economic outlook.

Higher global commodity prices typically have positive wealth and incomeeects on the Canadian economy through improved terms o trade. However,the Bank o Canadas commodity price index (BCPI) has declined sinceJanuary (Chart 15), owing largely to the relatively high weight o natural gasprices in the index.6 Moreover, although global oil prices have risen sharplysince January, the prices received by Canadian producers o crude oil havedeclined (Box 1). As a result, Canadas terms o trade have deteriorated.Going orward, the BCPI and the terms o trade are projected to rise through2014, reecting some recovery in natural gas prices, continued increases innon-energy commodity prices, and an expected narrowing in the spreadbetween Canadian export and import prices or crude oil.

6 Large movements in the relative prices o commodities may, on occasion, cause some deviation between

the BCPI and commodity prices received by Canadian producers, since the weights in the BCPI are

updated with a our-year lag, as new production data rom the input-output tables produced by Statistics

Canada become available. For example, the sharp increase in oil prices in recent years relative to

natural gas prices and the associated shit in the value o Canadian production have likely led the BCPI

to understate the overall level o commodity prices in Canada. The recent unprecedented divergence

between Canadian and global prices or crude oil, as detailed in Box 1, has likely worked in the other

direction, since the BCPI uses WTI prices as a proxy or Canadian oil prices. In preparing its projection

or the Canadian economy, the Bank uses the ull spectrum o movements in the commodity prices that

are relevant or Canada, including those not ully captured by the evolution o the BCPI. The Bank will

continue to evaluate methods to improve the BCPI as a measure o commodity prices in Canada.

External demand or Canadas

exports remains weak

Spot price or natural gas (13 April 2012)

Based on an average o utures contracts over the two weeks ending 13 April 2012

Note: Values or natural gas prices in April 2012 are estimates based on the average daily spot

prices up to 13 Apr il 2012.


Natural gas

Natural gas utures price

Natural gas utures price (January Report)

2005 2006 2007 2008 2009 2010 2011 2012 2013 20140

3

6

9

12

15

US$/Million Btu

Chart 14: Prices or natural gas are projected to remain at relatively low levels

Monthly data



21/42

Canadian DollarThe Canadian dollar has averaged close to 101 cents U.S. since the Marchfxed announcement date and is assumed to remain at this level over theprojection horizon (Chart 16), compared with the 98 cents U.S. assumed inthe January Report.

Note: Values in April 2012 are estimates based on the average daily spot prices up to 13 April 2012.

Source: Bank o Canada Last observation: April 2012

All commodities

(US$)

Non-energy commodities

(US$)

Energy commodities

(US$)

2005 2006 2007 2008 2009 2010 2011 2012

140

100

180

220

260

300

340

380

420

Index

January Report

Chart 15: Commodity prices have decreased since the lastReport

Bank o Canada commodity price index (rebased to January 2003 = 100),

monthly data

Note: A rise in either series indicates an appreciation o the Canadian dollar.

Source: Bank o Canada Last observation: 13 April 2012

CERI: Canadian-dollar eective exchange rate index

(against U.S. dollar, euro, yen, U.K. pound, Mexican

peso and Chinese renminbi) (let scale, 1992 = 100)

Closing spot exchange rate

or Canadian dollar vis--vis

U.S. dollar (right scale)

2008 2009 2010 2011 201290

100

110

120

130

US$Index

January Report

0.80

0.85

0.90

0.95

1.00

1.05

1.10

0.75

Chart 16: The value o the Canadian dollar has increased slightly since

the lastReport

Daily data



22/42


23/42

costs or Caadia rms ad also puts upward pressure o

gasolie prices, sice about hal o the gasolie purchased

i Caada is produced usig reed petroleum priced of

Bret2 By itsel, this deterioratio i the oil-related terms o

trade reduces Caadas real gross domestic icome, sice

Caadas real icome available to purchase oreig goods

ad services decreases This reductio i real icome may,

i tur, dampe spedig o domestically produced goods

ad services

2 For a detailed description o the relationship between crude oil and gaso-

line prices in Canada, see Technical Box 3 in the October 2011 Monetary

Policy Report.

Icreased capacity utilizatio at reeries that experieced

temporary outages, combied with the plaed reversal o

the directio o ow i the Seaway Crude Pipelie System,

should lead to a greater covergece betwee the prices

o Caadia crudes ad that o WTI crude i the comig

moths, thus helpig to improve Caadas terms o trade 3

The price diferetial betwee WTI ad Bret is expected to

persist or some time, however, util ew pipelie capacity

is put i place i the Uited States or Caada to reduce the

excess supply situatio at Cushig, Olahoma

3 The reversal o the Seaway pipeline, which currently carries oil rom the

U.S. Gul Coast to Cushing, Oklahoma, is expected to become operational

in June, and to reach its ull capacity in the frst quarter o 2013.

Box 1 (continued)



24/42


25/42

C ecoom

The Bank expects the Canadian economy to grow at a moderate pace overthe projection horizon, with total and core CPI ination remaining close tothe 2 per cent target. The Bank continues to anticipate that the economicexpansion will be driven by growth in private domestic demand over theprojection horizon. Net exports are expected to contribute only marginally

to overall growth, reecting the modest recovery in oreign activity andCanadas ongoing competitiveness challenges, including the persistentstrength o the Canadian dollar.

Economic momentum in Canada is slightly frmer than the Bank hadexpected in the January Report. The external headwinds acing theCanadian economy have abated somewhat, with the U.S. economicrecovery showing more resilience than previously anticipated and fnancialconditions more supportive than expected. Furthermore, with confdencehaving rebounded more quickly than envisaged in January, the Bankexpects that global uncertainty will have less o a dampening eect on thespending o Canadian households and businesses in coming quarters.

Financial ConditionsThe aggregate supply and price o credit to businesses and householdsin Canada remain very stimulative (Chart 17), providing important ongoingsupport to the economic expansion.

Credit conditions or Canadian frms began to ease again in the frst quarter,as reported in both the BanksSenior Loan Ocer Survey(available on theBanks website under Publications and Research > Periodicals > SLOS2012Q1) and the Business Outlook Survey(available on the Banks websiteunder Publications and Research > Periodicals > BOS Spring 2012), in thecontext o improved global fnancial conditions (Chart 18).

Financial markets in Canada have maintained a positive tone in recent

months in the ace o uctuations in Europe. Yields on Canadian governmentbonds are just above the low levels seen at the time o the January Report,having moved generally in line with major oreign markets. Corporate yieldshave also remained at very low levels, and the volume o bond issuance hasincreased (Chart 19). These avourable developments are partly due to sus-tained international demand or the debt o Canadian governments, banksand corporations, a sign that their credit quality is perceived to be high byglobal standards. While the S&P/TSX Composite Index has declined slightlysince the January Report, the prices o Canadian bank equities, which hadperormed better than those o other advanced economies during a periodo heightened uncertainty last year, have risen urther.

The Bank expects the Canadian

economy to grow at a moderate

pace

The external headwinds acing

the Canadian economy have

abated somewhat

Financial markets in Canada

have maintained a positive tone

Canadian eCOnOMy 19BAnk OF CAnADA Monetary Policy rePort aPril 2012
http://www.bankofcanada.ca/?page_id=28154http://www.bankofcanada.ca/?page_id=28154http://www.bankofcanada.ca/?page_id=28154http://www.bankofcanada.ca/?page_id=28148http://www.bankofcanada.ca/?page_id=28148http://www.bankofcanada.ca/?page_id=28148http://www.bankofcanada.ca/?page_id=28154


26/42

In this context, Canadian banks continue to be well positioned to lend, withready access to relatively low-cost unding across the term structure in bothCanadian and oreign currencies. The growth o business credit has pickedup somewhat in recent months, consistent with some easing in credit condi-tions and a pickup in the growth o business investment. However, giventheir strong aggregate fnancial position, non-fnancial corporations continueto have a limited need or external fnancing.

The growth o business credit

has picked up somewhat

Note: For more inormation on these series, see .

Source: Bank o Canada calculations Last observation: 13 April 2012

Eective business interest rate Eective household interest rate

2008 2009 2010 2011 20122.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

%

Chart 17: Borrowing costs or businesses and households remain at

exceptionally low levels

Weekly data

a. Weighted percentage o surveyed fnancial institutions reporting tightened credit conditions minus the

weighted percentage reporting eased credit conditions

b. Percentage o frms reporting tightened credit conditions minus percentage reporting eased credit

conditions

Source: Bank o Canada Last observation: 2012Q1

Overall business-lending conditions rom the Senior Loan Ocer Surveya

Overall credit conditions rom the Business Outlook Surveyb

2007 2008 2009 2010 2011 2012

-60

-40

-20

0

20

40

60

80

100

%

Tightening

Easing

Chart 18: Survey results suggest that credit conditions or Canadian rms

began to ease again in 2012Q1

Balance o opinion

20 Canadian eCOnOMyBAnk OF CAnADA Monetary Policy rePort aPril 2012
http://credit.bankofcanada.ca/financialconditionshttp://credit.bankofcanada.ca/financialconditionshttp://credit.bankofcanada.ca/financialconditions


27/42

Household credit also remains readily available at near-record low rates,owing in large part to exceptionally low long-term fxed mortgage rates. Thepace o household credit growth has moderated in recent months (Chart 20),however, ollowing a long period o comparatively rapid growth that haspushed household indebtedness to record levels relative to disposableincome.

As confdence in Canada has improved in recent months, growth in thenarrow monetary aggregates has moderated, consistent with a reducedpreerence or liquidity. Growth in the broad monetary aggregates has also

eased modestly o late, while remaining consistent with expectations orelatively subdued ination pressures.

Household credit also remains

readily available at near-record

low rates


Non-fnancial issues Financial issues

5

0

10

15

20

25

30

2010 2011 2012

Can$ billions

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

Chart 19: Canadian bond issuance has picked up

Corporate debt issuance by domestic frms, in Canadian dollars

Source: Bank o Canada Last observation: February 2012

Total business credit

Historical average o business

credit growth rom 1992 to present

Total household credit

Historical average o household credit

growth rom 1992 to present

2008 2009 2010 2011 2012

-4

-2

0

2

4

6

8

10

12

14

%

Chart 20: The growth o business credit has picked up, while household credit

growth has moderated

3-month percentage change (at annual rates)



28/42

Estimated Pressures on CapacityThe slack in the Canadian economy is now estimated to be less than pre-viously expected, since the level o real GDP in the frst quarter o 2012 isestimated to be 0.3 per cent higher than the Bank had orecast in theJanuary Report. This reects the combination o an upward revision to

reported GDP growth in the third quarter o 2011, an upwardly revised esti-mate o 2.5 per cent growth or the frst quarter o 2012, and ourth-quartergrowth o 1.8 per cent, which was broadly in line with expectations in theJanuary Report. On balance, these results reect greater momentum inhousehold consumption and business investment in Canada, as well asstronger-than-anticipated oreign activity. The Banks conventional measureo the output gap, at -0.4 per cent in the frst quarter o 2012, also points toless slack in the economy than previously expected (Chart 21). This is con-sistent with responses to the Banks Business Outlook Surveyin recentquarters, which have shown that the proportion o frms that would havedifculty responding to an unexpected increase in demand has remainedclose to its historical average.

Developments in labour market indicators have been consistent with thepersistence o a slightly greater degree o excess supply. Despite notableimprovements in March, both employment and the unemployment rate arelittle changed, overall, rom their levels six months ago (Chart 22). Similarly,the proportion o involuntary part-time workers has only partially recoveredrom its sharp rise during the recession, pointing to the persistence ounused capacity in the labour market. The proportion o frms reportinglabour shortages in the Banks spring Business Outlook Surveyalsoremained below its historical average.

On balance, the Bank judges that the economy was operating at roughlyhal a per cent below its production capacity in the frst quarter o 2012, asmaller degree o slack than had been anticipated in the January Report.

The slack in the Canadian

economy is now estimated to be

less than previously expected

The Bank judges that the

economy was operating at

roughly hal a per cent below its

production capacity in the rst

quarter o 2012

a. Response to Business Outlook Surveyquestion on capacity pressures. Percentage o frms

indicating that they would have either some or signifcant difculty meeting an unanticipated

increase in demand/sales.

b. Response to Business Outlook Surveyquestion on labour shortages. Percentage o frms reporting

labour shortages that restrict their abilit y to meet demand.

c. Dierence between actual output and estimated potential output rom the Bank o Canadas conven-

tional measure. The estimate or the frst quarter o 2012 (indicated by*) is based on a projectedincrease in output o 2.5 per cent (at annual rates) or the quarter.


Some and signifcant difcultya (let scale)

Labour shortagesb (let scale)

Conventional measure o

the output gapc (right scale)

-4

-3

-2

-1

0

1

2

3

0

10

20

30

40

50

60

70

2007 2008 2009 2010 2011 2012

%%

Chart 21: Excess supply remains in the Canadian economy



29/42

The Real EconomyThe Bank expects a moderate pace o expansion to continue over the pro-jection horizon (Chart 23). On an average annual basis, real GDP is orecastto grow by 2.4 per cent in both 2012 and 2013, beore moderating to 2.2 percent, the rate o the economys production potential, in 2014 (Table 2).Private domestic demand, supported by accommodative domestic fnancialconditions, is expected to account or almost all o Canadas economicgrowth over the projection horizon (Chart 24).

a. Expressed as a percentage o total part-time employment, unadjusted, 12-month moving averageSource: Statistics Canada Last observation: March 2012

Unemployment rate (let scale) Involuntary part-time workersa (right scale)

20

22

24

26

28

30

5

6

7

8

9

2008 2009 2010 2011 2012

% %

Chart 22: Indicators suggest that some slack remains in the labour market

Monthly data

Sources: Statistics Canada and Bank o Canada calculations and projections

Year-over-year percentage

change in real GDP

Base-case projection

Quarter-over-quarter percentage

change in real GDP, at annual rates

Base-case projection

2008 2009 2010 2011 2012 2013 2014-10

-8

-6

-4

-2

0

2

4

6

8

%

Chart 23: Real GDP is expected to grow at a moderate pace



30/42

This outlook or the Canadian economy is slightly frmer than in the JanuaryReport, with greater momentum through 2012 than had been anticipated,although the projected pace o growth in 2013 is now somewhat moremodest than previously envisaged (Table 3). The stronger quarterly profleover most o 2012 partly reects more positive sentiment than previouslyassumed, in line with the stronger U.S. and global economic outlook.7 Theprofle or growth in consumption and investment is more ront-loaded thanpreviously expected, in part reecting a more rapid improvement in conf-dence (Chart 25). The rise in global oil prices since the January Report is

This outlook or the Canadian

economy is slightly rmer than

in the JanuaryReport, withgreater momentum through

2012


Consumption

Housing

Business fxed investment

Government

Net exports

Inventories

GDP

2009 2010 2011 2012 2013 2014-6

-4

-2

0

2

4

6

Percentage points

Chart 24: Private domestic demand is projected to account or almost

all o the economic growth in Canada

Contributions to real GDP growth

Table 2: Contributions to average annual real GDP growthPercentage pointsa

2011 2012 2013 2014

Consumption 1.3 (1.1) 1.3 (1.1) 1.3 (1.4) 1.2

Housing 0.2 (0.2) 0.3 (0.3) 0.2 (0.2) 0.1

Government 0.2 (0.3) 0.0 (-0.1) 0.1 (0.2) 0.1Business xed investment 1.5 (1.3) 0.9 (0.6) 0.7 (1.0) 0.7

Subtotal: Final domestic demand 3.1 (2.9) 2.5 (1.9) 2.3 (2.8) 2.1

Exports 1.3 (1.3) 1.7 (1.1) 1.1 (1.0) 1.3

Imports -2.1 (-2.0) -1.5 (-0.8) -1.0 (-1.0) -1.2

Subtotal: Net exports -0.7 (-0.7) 0.2 (0.3) 0.1 (0.0) 0.1

Inventories 0.1 (0.2) -0.3 (-0.2) 0.0 (0.0) 0.0

GDP 2.5 (2.4) 2.4 (2.0) 2.4 (2.8) 2.2

Memo items:

Potential output 1.6 (1.6) 2.0 (2.0) 2.1 (2.1) 2.2

Real gross domestic income (GDI) 3.7 (3.4) 2.2 (1.9) 2.5 (3.0) 2.4

a. Figures in parentheses are rom the base-case projection in the January 2012 Monetary Policy Report.Those or potential output are rom Technical Box 2 in the October 2011 Monetary Policy Report.

7 Growth in the frst hal o 2012 is also being boosted by temporary actors related to the rebuildingo motor vehicle inventories, ollowing the large drawdown that took place in the latter part o 2011as a result o the ooding in Thailand, as well as a return to more normal production in the oil sectorollowing disruptions at the end o 2011.



31/42

not, however, expected to provide a urther boost to domestic demandthrough higher real incomes, since the prices received by Canadian producershave gone down, while those paid by Canadian consumers have gone up(Box 1). Nonetheless, the recent greater momentum in private domesticdemand is orecast to result in a higher profle or imports than in January,osetting the more positive contribution to economic growth o strongeroreign activity and stronger Canadian exports in this projection.

Growth in household expenditures (the combination o consumer spendingand residential investment) has picked up in recent quarters, and isexpected to continue at a moderate pace through 2014. The Bank continues

Growth in household

expenditures has picked up

in recent quar ters

Table 3: Summary o the base-case projection or Canadaa

2011 2012 2013 2014

Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Real GDP (quarter-over-quarterpercentage change at annual rates)

1.8(2.0)

2.5(1.8)

2.5(1.8)

2.4(2.1)

2.5(2.6)

2.5(3.1)

2.2(3.1)

2.3(3.0)

2.2(2.8)

2.2 2.2 2.2 2.2

Real GDP (year-over-year percentagechange) 2.2(2.1) 2.0(1.7) 2.7(2.3) 2.3(1.9) 2.5(2.1) 2.5(2.4) 2.4(2.7) 2.4(2.9) 2.3(3.0) 2.2 2.2 2.2 2.2

Core infation (year-over-yearpercentage change)

2.1(2.2)

2.1(2.1)

1.9(2.0)

1.8(1.9)

1.8(1.7)

1.8(1.9)

2.1(1.9)

2.1(2.0)

2.1(2.0)

2.1 2.0 2.0 2.0

Total CPI (year-over-year percentagechange)

2.6(2.8)

2.4(2.2)

2.0(1.5)

2.2(1.7)

2.2(1.7)

2.1(1.8)

1.9(1.9)

1.9(2.0)

1.9(2.0)

1.9 2.0 2.0 2.0

Total CPI excluding the eect o theHST and changes in other indirecttaxes (year-over-year percentagechange)

2.5(2.7)

2.3(2.1)

1.9(1.4)

2.1(1.6)

2.1(1.6)

2.1(1.8)

2.0(1.9)

2.0(2.0)

2.0(2.0)

2.0 2.0 2.0 2.0

WTIb (level) 94(94)

103(101)

103(102)

104(102)

105(101)

105(100)

105(99)

104(98)

103(98)

102 101 99 99

Brentb (level) 109(109)

118(112)

122(111)

121(110)

119(109)

117(107)

115(106)

113(105)

112(103)

110 108 106 104

a. Figures in parentheses are rom the base-case p rojection in the January 2012 Monetary Policy Report.b. Assumptions or the prices o West Texas Intermediate and Brent crude oil (US$ per barrel), based on an average o utures contracts over the two weeks ending 13 April 2012

a. Percentage o frms expecting aster growth minus percentage expecting slower growth

Sources: Conerence Board o Canada and Bank o Canada Last observations: 2012Q1 and March 2012

Response to Business Outlook Survey

question on expectations or sales

growth over the next 12 months relative

to the past 12 months (balance o

opinion,a quarterly data, let scale)

Consumer confdence

(all respondents, index: 2002 = 100,

monthly data, right scale)

2 002 2 003 2 004 20 05 2 00 6 2 007 2 00 8 2 009 2 01 0 20 11 2 012

50

60

70

80

90

100

110

-40

-30

-20

-10

0

10

20

30

40

50

60

Index%

Chart 25: Consumer condence and business sentiment have rebounded

rom their recent troughs



32/42

to expect consumption to grow at a rate that is slightly below the projectedmoderate growth in personal disposable income (Chart 26), resulting in aslight rise in the savings rate (Box 2). Growth in residential investment,which is currently supported by very avourable mortgage-fnancing condi-tions (Chart 27), is orecast to slow over the projection horizon. Nonetheless,the ratio o household expenditures to GDP is expected to remain relativelyhigh over the projection horizon (Chart 28). In that context, the ratio ohousehold debt to income is projected to rise urther.

The ratio o household debt

to income is projected to rise

urther


Labour and investment income Personal disposable income

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

-2

0

2

4

6

8

10

%

Chart 26: Moderate growth in personal disposable income is expected

over the projection horizon

Percentage change, annual data

Sources: Canada Mortgage and Housing Corporation

and Bank o Canada calculations Last observation: March 2012

Multiple-amily housing starts Single-amily housing starts

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

0

50

100

150

200

250

300

Thousands of units

Chart 27: Multiples are contributing importantly to housing activityHousing starts, monthly data



33/42


34/42

d hugh Helocs d mgg g, hs

averaged close to 5 per cet over the past decade, earer

to the level observed through the secod hal o the 1990s

(Chart 2-C)5, 6

Home equity extracted through additioal borrowig caot

ud higher cosumptio ideitely Oce the proportio

o homeowers that access higher housig wealth through

Helocs hs s pk, h ps svgs b

expected to rise This implies a lower level o cosumptio

relative to icome With less equity i their homes, house-

holds would also be more exposed to a declie i house

prices, which could urther dampe cosumptio

5 See A Greespa ad J keedy, Sources ad Uses o Equity Extracted rom

Homes, Fiace ad Ecoomics Discussio Series 2007-20, 2007, or a similar

aalysis o the potetial efects o home-equity extractio o the savigs rate i

the Uited States

6 This aalysis abstracts rom potetial edogeous resposes o households ad

acial istitutios

The Bank continues to expect robust growth in business fxed investmentover the projection horizon, reecting the strong fnancial positions oCanadian frms, avourable credit conditions, high commodity prices andthe strong Canadian dollar, as well as the impetus to improve productivityamid heightened pressures to become more competitive. This robust out-look or growth in investment broadly maintains the share o investment inGDP around its historical average (Chart 29). The projected profle or busi-ness fxed investment has been revised up rom the January Report, par-ticularly or 2012, reecting a stronger and less uncertain global economic

The Bank continues to expect

robust growth in business xed

investment

Box 2 (continued)

Sources: Statistics Canada, Canadian Financial Monitor

and Bank o Canada calculations Last observation: 2010

Personal

savings rate

Simulated personal savings rate excluding net

draws on HELOCs and net mortgage refnancingused or consumption

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

0

2

4

6

8

10

12

14

%

Chart 2-C: The savings rate has been considerably lower as

consumption unded by home-equity extraction has grown

Savings rate, annual data


Nominal consumption and residential

investment to nominal GDP

Average rom 1975Q1 to present

1975 1980 1985 1990 1995 2000 2005 2010 2015

0.56

0.58

0.60

0.62

0.64

0.66

0.68

Ratio

Chart 28: The share o household expenditures in GDP is expected

to remain elevated

Quarterly data



35/42

outlook. This orecast is consistent with Statistics Canadas survey on pri-vate and public investment intentions, which points to strong growth in 2012led by the oil and gas sector, and with the Banks spring Business OutlookSurvey, which indicates that investment intentions over the next 12 monthsremain strongly positive.

The contribution o government spending to real GDP growth is expected tobe quite modest over the projection horizon, in line with the fscal plans oederal and provincial governments to consolidate spending, as outlined inrecent budget statements. In this regard, signifcant downward revisions to

National Accounts estimates o government spending in recent quarterssuggest that the unwinding o the temporary fscal stimulus measuresimplemented during the recession was largely completed by the end o 2011.In light o these developments, the Bank assumes a somewhat lower overallprofle or government expenditures over the projection horizon than in theJanuary Report.

The recovery in net exports is expected to remain weak. With low levels oU.S. demand or autos and housing, coupled with ongoing competitivenesschallenges, Canadas exports are not orecast to regain their pre-recessionpeak until the end o 2013 (Chart 30). In contrast, the level o imports hasalready regained its pre-recession peak. Partly as a result, Canadas currentaccount balance has declined rom a pre-recession surplus to a defcit o

approximately 2 per cent o GDP, which is projected to persist over theorecast horizon (Chart 31).

With a somewhat stronger external environment and slightly moremomentum in domestic demand, both exports and imports are expectedto rise at a somewhat aster pace than anticipated in the January Report,although the Bank continues to expect that net exports will contribute littleto Canadas GDP growth over the projection horizon.

Overall, real GDP in Canada is projected to grow at a slightly aster pacethan the estimated growth rate o potential output in coming quarters. As aresult, the economy is anticipated to gradually return to ull capacity by the

The contribution o government

spending to real GDP growth is

expected to be quite modest

Canadas exports are not

orecast to regain their pre-

recession peak until the end

o 2013

The economy is anticipated to

gradual ly return to ull capacity

by the rst hal o 2013


Nominal business investment

to nominal GDP

Average rom 1975Q1 to present

1975 1980 1985 1990 1995 2000 2005 2010 2015

0.09

0.10

0.11

0.12

0.13

0.14

0.15

0.16

0.17

Ratio

Chart 29: Investment as a share o GDP is expected to remain near historical

averages

Quarterly data



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frst hal o 2013, earlier than expected in the January Report. In this context,the Canadian economy is orecast to operate with somewhat less slackthroughout the projection horizon than indicated in the January base-casescenario, largely reecting the slightly higher level o economic activity seenrecently.

InfationCore CPI ination averaged 2.2 per cent over January and February, upslightly rom 2.1 per cent in the ourth quarter. As anticipated, the gradualincrease rom 1.5 per cent in the frst hal o 2011 partly reected the laggedeects o higher world prices or agricultural products on the prices o oodand clothing, as well as the dissipation o the eect o the introduction o theharmonized sales tax (HST) in Ontario and British Columbia in the thirdquarter o 2010 on year-over-year core ination. This upward movement in


Current cycle

Base-case scenario

Average o previous cycles (since 1951)

Range o previous cycles (since 1951)

-1 0 1 2 3 4 5 6

80

90

100

110

120

130

140

150

160

170

Index

Quarterly peak in real GDP

beore the downturn

Yearsbeore thedownturn

Years

ater the

downturn

Chart 30: The recovery in exports is expected to remain weak

Comparison o real exports across economic cycles; quarter

beore the downturn in real GDP = 100, quarterly data

Sources: Statistics Canada and Bank o Canada calculations Last observation: 2011Q4Current account balance as a percentage o nominal GDP

2005 2006 2007 2008 2009 2010 2011

-5

-4

-3

-2

-1

0

1

2

3

4

%

Chart 31: Canadas current account decit refects weak exports

Quarterly data



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core ination has also been reected in alternative measures o underlyingination (Chart 32). Despite higher core ination, total CPI ination hasdeclined rom its peak o 3.4 per cent in the second quarter o 2011 to anaverage o 2.6 per cent in January and February. This drop reects somemoderation in gasoline prices rom levels seen a year ago, as well as theunwinding o the direct eects o the HST on year-over-year ination. However,with the rebound in gasoline prices in recent months, total CPI ination hasremained higher than expected in the January Report.

Ination expectations remain well anchored. The April ConsensusEconomics orecasts or total CPI ination in 2012 and 2013 were 2.1 percent and 2.0 per cent, respectively. As reported in the Banks springBusiness Outlook Survey, over 90 per cent o frms expect average inationover the next two years to remain within the 1 to 3 per cent ination-control

range. Market-based measures o longer-term ination expectations alsocontinue to be consistent with the 2 per cent ination-control target.

Core ination is projected to stay close to 2 per cent over the projectionhorizon (Chart 33), as the economy remains near its production potential, thegrowth o labour compensation remains moderate (Chart 34) and inationexpectations stay well anchored. The Bank orecasts a slight decline in coreination in the near term, reecting the unwinding o the eects o higherprices or ood and clothing on year-over-year ination, as well as lower elec-tricity prices. Core ination is expected to converge to 2 per cent thereater asexcess supply is ully absorbed. As well, the indirect eects associated withthe announced restoration o the provincial sales tax in British Columbia are

With the rebound in gasoline

prices in recent months, total

CPI infation has remained

higher than expected

Infation expectations remain

well anchored

Core infation is projected to

stay close to 2 per cent over the

projection hor izon

a. Excludes eight o the most volatile components and the eect o changes in indirect taxes on the

remaining components

b. Weighted average o the cross-sectional distribution o pri ce changes that has been trimmed to excludevalues urther than 1.5 standard deviations rom the average and the eect o changes in indirect taxes

c. Adjusts each CPI basket weight by a actor that is inversely proportional to the components variability

and is adjusted to exclude the eect o changes in indirect taxes

d. Percentage change in the CPI component at the midpoint o the cross-sectional distribution o weighted

price variation, adjusted to exclude the eect o changes in indirect taxes

Sources: Statistics Canada and Bank o Canada Last observation: February 2012

Core CPIa

CPI excluding ood, energy, and changes

in indirect taxes

MEANSTDb

CPIWc

Weighted mediand

2007 2008 2009 20112010 2012

0

1

2

3

4

%

Chart 32: Underlying infation has been slightly rmer recently

Alternative measures o core ination, year-over-year percentage change,

monthly data



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Note: Dotted lines indicate projections.

a. CPI excluding eight o the most volatile components and the eect o changes in indirect taxes on

the remaining components


Total CPI Core CPIa

Target Control range

2007 2008 2009 2010 2011 2012 2013 2014

-2

-1

0

1

2

3

4

%

Chart 33: Total and core CPI infation in Canada are projected to remain

close to 2 per cent over the projection horizon

Year-over-year percentage change, quarterly data

Note: The 2012Q1 number or the eective increase in base wage rates or newly negotiated settlements is

approximated by January data.

Sources: Statistics Canada and Human Resources

and Skills Development Canada Last observations: 2011Q4 and 2012Q1

Eective annual increase in base wage rates or newly negotiated settlements (all industries)

Compensation per hour (year-over-year percentage change)

Average hourly earnings o permanent workers (year-over-year percentage change)

2007 2008 2009 2010 2011 2012

0

1

2

3

4

5

6

%

Chart 34: Increases in labour compensation have been moderate

in recent quarters

Quarterly data



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R o Ooo

Despite recent improvements to the outlook or the global and Canadianeconomies, risks remain elevated. Signifcant steps have been taken toaddress the sovereign debt and banking crisis in the euro area, reducingthe chances o an extreme negative event, but risks in this regard still restclearly on the downside.

The three main upside risks to ination in Canada relate to the possibility ohigher-than-expected oil prices, stronger-than-expected growth in the U.S.economy and stronger momentum in Canadian household spending.

Global inationary pressures could be more persistent than currentlyprojected i oil prices continue to rise and remain above the levels impliedby current utures prices.

Private sector demand in the United States could be stronger thananticipated, and fscal policy could exert a smaller-than-anticipated dragon growth, i U.S. authorities smooth the path o fscal consolidationollowing the November elections.

Household expenditures in Canada have been stronger than expectedand could have more momentum than currently projected.

The two main downside risks to ination in Canada relate to a reintensifcationo sovereign debt and banking concerns in Europe, and the possibility thatgrowth in Canadian household spending could be weaker than projected.

Although policy initiatives to address the sovereign debt and bankingcrisis in the euro area have resulted in some improvement in Europeandebt markets and global fnancial conditions, this risk could re-escalate,aecting Canada through fnancial, confdence and trade channels.

Continuing high household debt levels in Canada could lead to a sharper-than-expected deceleration in household spending. Relatedly, i therewere a sudden weakening in the Canadian housing sector, it could have

sizable spillover eects on other areas o the economy.

Overall, the Bank judges that the risks to the ination outlook in Canada areroughly balanced over the projection period.

Risks tO the OutlOOk 35BAnk OF CAnADA Monetary Policy rePort aPril 2012


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Bank of Canada Monetary Policy Report - April 2012

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