Stephen S Poloz: Release of the Monetary Policy Report
Opening statement by Mr Stephen S Poloz, Governor of the Bank of Canada, at the press
conference following the release of the Monetary Policy Report, Ottawa, Ontario, 15 July
2015.
* * *
Good morning. Senior Deputy Governor Wilkins and I are happy to be here with you again to
answer your questions about today's interest rate announcement, and our latest Monetary
Policy Report (MPR). Let me begin with a few remarks around the issues that were most
important to the Governing Council's deliberations.
Since our last MPR in April, global economic developments have been quite disappointing,
and these have led to a significant downgrade of our estimate of Canadian economic growth
for 2015. There were three factors behind this downgrade:
First, Canadian oil producers have lowered their long-term outlook for global oil prices, and
have cut their plans for investment spending significantly more than previously announced.
Second, China's economy is undergoing a structural transition to slower, domestic-driven
growth, which is reducing Canadian exports of a range of other commodities.
Third, Canada's non-resource exports have also faltered in recent months. While this is
partly due to the first-quarter setback in the U.S. economy, it's still a puzzle that merits further
study.
Given the collapse in oil prices, and declines in some other key non-energy commodities, the
economy is now operating on two distinct growth tracks: the resource track and the
nonresource track. These tracks are not independent - the cancellation of an investment in the
oil patch will often lead to a hit in the manufacturing sector, for example. But we can do some
rough decompositions to illustrate the situation. I draw your attention to Chart 18, on page
19 of the MPR. There we can see the sharp drop in oil and gas output, which constitutes 10
per cent of our economy, and the slowdown in non-energy commodity production, which
represents a further 8 per cent. The remaining 82 per cent is seeing steady growth, although
it has moderated slightly so far this year, due to the setback in the U.S and spillovers from
the resource sector.
As the non-resource track regains momentum, it is expected to become the dominant trend
at the aggregate level. We expected this to begin in the second quarter. But it did not,
because of the three factors I listed above.
A major shift in a country's terms-of-trade is one of the most complex situations an economic
forecaster can face. We have said from the beginning that while there would be both
negative and positive effects from lower oil prices on Canada, the negative effects would
dominate, and they would come first. The positives would be more gradual, taking the form of
stronger consumer spending, both here and in the U.S., and increased non-resource exports,
because of stronger U.S. spending and a lower Canadian dollar.
These positives have been slow to emerge, but we can see them working. Export
subsectors that are usually sensitive to exchange rate movements have been outperforming.
The setback in the U.S. economy appears to have been mainly temporary, as U.S. labour
market performance has been strong. In Canada's non-resource sector, the labour market
has been performing well, and our conversations with companies indicate rising capacity
constraints. This implies that increased investment and more employment gains are likely in
the months ahead. In short, we expect these positive trends to begin to outweigh the
negatives coming from the resource sector during the next few months.
These considerations figured prominently in the Governing Council's deliberations, because
the state of total demand in the economy relative to our production capacity is what drives
our inflation outlook. The economy has been operating below full capacity for some time,
which is why we estimate that the underlying trend in inflation is running at around 1.5 per
cent to 1.7 per cent. Core inflation is higher than the underlying trend, because a decline in
the dollar is raising the prices of imports. Total inflation is much lower, because of past
declines in fuel prices. As the temporary effects dissipate, all these measures of inflation will
converge on the underlying trend.
The weak economic performance in the first half of this year means that Canada has more
excess capacity, which is increasing the downward pressure on the underlying trend in
inflation. To put it in the language of our risk management framework, the three factors I
mentioned earlier moved us out of the neutral zone, to a place where the downside risk to
future inflation is material. This would imply a slower return to full economic capacity and
sustainable 2 per cent inflation.
At the same time, financial stability risks remain elevated. Of particular note are the
vulnerabilities associated with household debt and rising housing prices. And we must
acknowledge that today's action could exacerbate these vulnerabilities. However, as we
noted in our Financial System Review, financial vulnerabilities would usually translate into
full-blown risks - with attendant consequences for the economy - only if there was a trigger,
such as a widespread and sharp decline in economic activity and employment. The
terms-oftrade shock we are experiencing, which has already translated into an increase in excess
capacity and downward pressure on inflation, has the potential to act as such a trigger, if left
unaddressed.
Accordingly, the Governing Council agreed that acting at this time was consistent both with
the Bank's primary mission - the pursuit of its inflation target - as well as helping to manage
financial stability risks, even if there could be some increase in financial vulnerabilities in the
process.
Let me remind you that monetary policy operates with a long lag and there are many
transmission channels through which interest rate changes affect the economy, including
longer-term bond yields and the exchange rate. This needs to be taken into account when
predicting how the economy will respond to our actions, and when. It also makes it difficult to
pin down the precise timing when Canada will reach full capacity with inflation sustainably at
target - it could just as easily be sooner as later than projected.
Let me also remind you that there are many uncertain elements and risks to our outlook,
which are discussed in the MPR. One additional element I could mention is the prospect of
interest-rate liftoff in the U.S. Although we have no special insight into when this might occur,
we have said many times that it would be welcome, for it would be consistent with a more
positive outlook for the U.S. economy. Nevertheless, because the Canadian economy is
dealing with a large terms-of-trade shock, it is likely to be less synchronized with the U.S.
economy than in the past. Furthermore, we would expect any rises in global bond yields to
be at least partly imported into Canada - with possible implications for the Canadian dollar -
and with an uncertain net effect on our economy.
To conclude, the Canadian economy is undergoing a significant and complex adjustment,
even while it is still trying to overcome persistent global headwinds. In the judgment of the
Governing Council, today's action is required to help facilitate the adjustment of the economy
to this unusual situation.
With that, Carolyn and I would now be happy to take your questions.