Canadian economy resilient even as global outlook worsens

Speaking a day after we decided to hold interest rates steady, Deputy Governor Lawrence Schembri discussed the key points Governing Council considered in their decision. He explained that the economy continued to show strength while the global backdrop weakened. He also outlined the link between stronger growth and inflation pressures.

Policy rate unchanged

We decided to hold the policy rate steady at 1.75 percent.

Some of the economy’s strength could be temporary

• Canadian data since July have been stronger than we had anticipated. Wages have picked up further and housing markets have begun to rebound.
• Overall consumer spending has been soft, and business investment has dropped off. So, we continue to expect that the economy will slow in the second half of the year.
• The economy’s resilience means the gap between what we have the capacity to produce and what’s actually being produced is smaller than we had expected. That’s good news because it means the economy is operating close to its potential, or speed limit.
• The US–China trade war was the main risk to our outlook in July. Since then, it’s gotten worse, taking a toll on global economic growth.

Growth and inflation are linked

Despite the global worries, an economy operating close to its speed limit affects inflation—how quickly prices rise.

Growth that’s faster than potential can spark unwanted inflation pressures, and growth that’s slower can pull inflation below our 2 percent target.

This link between inflation and economic growth is at the core of the Bank of Canada’s approach to conducting monetary policy to achieve our objective of low and stable inflation.

We adjust the policy interest rate to try to steer the economy to its potential, because that’s when inflation should be close to 2 percent.

The relationship remains strong in Canada

Lately, there has been talk about whether the relationship between growth and inflation still exists. That’s because inflation rates in the United States and other advanced economies have been lower in recent years than you might expect given relatively strong growth.

Here in Canada though, the story looks quite different.

At the Bank, to help us see the underlying trend of inflation, we rely on a number of core measures that strip out goods whose prices move around a lot, like gasoline or imported fruits and vegetables. The behaviour of these measures in recent years gives us confidence in the link between inflation and growth in Canada.

Since 2017, the measures of core inflation that we follow closely have been hovering at around 2 percent. That’s consistent with our view that the economy has been operating close to its speed limit.

We will update our projection for growth and inflation in October

In sum, Canada’s economy is operating close to potential and inflation is on target.

However, escalating trade conflicts and related uncertainty are taking a toll on the global and Canadian economies. In this context, the current degree of monetary policy stimulus remains appropriate.

As the Bank works to update its projection in light of incoming data, Governing Council will pay particular attention to global developments and their impact on the outlook for Canadian growth and inflation.