Rates to stay low through 2010: CIBC

It is becoming increasingly popular to declare the recession dead, but that does not mean North Americans will enjoy a massive economic upswing any time soon, according to analysts at CIBC.

Slow growth in both the U.S. and Canada will keep inflation in check, allowing the Bank of Canada to maintain its easy-money policy of low interest rates until 2011.

“Unlike the Bank of Canada, we don’t expect growth to average above the non-inflationary potential until 2011,” says CIBC’s chief economist, Avery Shenfeld. “But even under Governor [Mark] Carney’s more optimistic trajectory, inflation will still be feeling the downward pressure of a sizable output gap next year, one as large as we saw in the early 1980s and 1990s downturns.”

The Bank of Canada is predicting GDP growth of 3.0% in 2010, and 3.5% in 2011, following a contraction of 2.3% for 2009.

The deceleration in consumer price index anticipated by the bank governor did not materialize in the first half of 2009, but Shenfeld says this is due to volatility in the price of just a handful of components in the CPI basket. The inflation measure could well ease if the prices of these elements stabilize.

These volatile components should force economists to reconsider the notion of “core” CPI, which strips out only the food and energy components, which are typically the most volatile.

On a year-over-year basis, July 2009 saw energy prices dragging on CPI, as the price of gasoline fell from its pre-financial crisis highs. The cost of other non-core items — natural gas, fuel oil and mortgage interest costs — have also eased.

By stripping out dramatically cheaper energy costs, the traditional core CPI is skewed dramatically higher, making it an increasingly inaccurate measure of Canadians’ purchasing power.

“The deep dive in non-core items has left those Canadians still working with some spending power,” Shenfeld says. “After filling their gas tanks and paying their new lower mortgage bills, Canadians simply have more money in their pockets when they go shopping for other items, keeping those prices aloft.”

The risk of higher inflation posed by energy should be a wash, Shenfeld suggests, as higher gasoline costs will curb the “income effect” that has boosted core components. This is the most likely scenario, and the headline and core inflation rates will probably converge in the second quarter of 2010, somewhere south of the Bank of Canada’s target of 2%.

As a result, the trendsetting bank rate should remain at just 25 basis points, possibly until as late as the first half of 2011.

In a speech to the Canadian Association for Business Economics today, Deputy Governor Timothy Lane, stated that an upturn in the U.S. economy would boost Canadian GDP as well.

“The composition of economic activity in the United States as it recovers will prove favourable to Canadian exporters — as the sectors hit hardest by the recession, such as housing and automobiles, rebound,” he told the audience in Kingston.

CIBC economists are not so optimistic. In the past, the U.S. consumer has been the driver of growth and has shown little interest in where inputs for consumer goods were sourced.

This time around, the consumer is tapped out. Those who have held on to their jobs are focused on fixing their household balance sheets. The driver of this recovery will be government-funded stimulus projects, which will tilt spending in favour of industries that import less from Canada than the consumer sector.

Read CIBC’s report, RECOVERY BVILDING.

(08/25/09)