Canada: better than expected GDP growth but the BoC left rates unchanged at 0.25%

Canadian economy rose by an annualized 5% in Q4 ’09. Economists expected GDP to increase by 4% and the Bank of Canada had projected a 3.3% gain in the January 2010 monetary policy report. Statistics Canada revised its estimate of the Q3 growth rate to 0.9% from the earlier reading of a 0.4% pace. Q4 had solid gains in most of the major domestic expenditure categories: consumer spending rose 3.6%, residential investment 29.7% and government spending 5.8%. Business investment was the main source of weakness dropping 8.8%. On the external side of the economy, exports rose a robust 15.4% that more than offset an 8.9% rise in imports, which resulted in net exports adding 1.5 percentage points to overall fourth-quarter GDP growth.

Stronger than expected GDP growth did not have short-term consequences on the BoC monetary policy. The BoC left rates unchanged at 0.25% at the end of last week monetary policy meeting and repeated a pledge to leave it unchanged through June unless the “current” inflation outlook shifts. As regards economic activity the BoC said that “The level of economic activity in Canada has been slightly higher than the Bank had projected in its January Monetary Policy Report” and that “the persistent strength of the Canadian dollar and the low absolute level of U.S. demand continue to act as significant drags on economic activity in Canada”. On inflation, the BoC highlighted that “Core inflation has been slightly firmer than projected, the result of both transitory factors and the higher level of economic activity” and that “main macroeconomic risks to the inflation projection are roughly balanced”. The bank’s statement dropped a reference made in January to inflation risks being “tilted slightly to the downside.” and omitted a reference to the central bank having “flexibility” even with the key interest rate close to zero. While we do not see the BoC raise rates before H2 ’10, we believe that the BoC may increase rates aggressively. Indeed, our interest rate rule indicate that the BoC has the possibility to hike rates considerably (e.g. to 2%) before the end of 2010.