The Canadian economy is entering a period of slow growth under the heavy burden of a strong dollar, Bank of Canada governor Mark Carney warns.
The dollar's impact on trade is a key reason Carney expects the economy to slow sharply in the next two years after a quick start to this year.
The central banker says a strong dollar is benefiting some aspects of the economy, but it is acting as a heavy anchor on exports.
And he has some advice for firms -- make use of the loonie's purchasing power to buy imported machinery and equipment to become more competitive, because it will remain strong for some time. The bank now is incorporating a loonie that's valued at US$1.03 in its assumptions over the next few years.
"What we're seeing on the trade side is still quite a challenging situation for our exports and it could be more difficult, which is why we're highlighting the risk of the dollar," he said in a news conference following the release of the central bank's new quarterly economic outlook.
One of the benefits of the strong dollar is that Canadian firms have access to relatively cheaper imported machinery and equipment, and it's time to take advantage, he said.
Carney noted that although business investment has picked up of late, it's only made up 55 per cent of what was lost during the recession, as compared to 90 per cent for U.S. firms.
"Now's the time for businesses to step up," he said. "It's a competitive challenging environment out there, and our advice to business is expect these competitive challenges to persist and the right response is to invest, improve productivity and diversify markets."
The Harper government has argued that its policy of lower corporate taxes will lead to more investment, but Carney declined to get involved in the political debate.
The surprise in the bank's new Monetary Policy Report is that despite what has been an unexpectedly strong six months of economic activity -- 3.3 per cent growth in the last quarter of 2010 and what the bank believes is another 4.2 per cent gain in the first quarter of this year -- little has changed in the bank's overall view of the economy since January.
The higher starting point for 2011 and the fast start pushes growth expectations for the year to 2.9 per cent, as opposed to 2.4 projected in January, but the improvement is all in the past. The next three quarters will see growth slow to two per cent, 2.7 per cent and 2.7 per cent, it predicts.
As well, next year will see growth moderate to 2.6 per cent, as opposed to the 2.8 estimate of four months ago, and 2012 will be even weaker, at 2.1 per cent.
Carney makes clear that he believes the last six months have been an aberration. Timing factors like expansion of oil pipeline capacity, government stimulus spending, and the low starting point for exports, boosted growth temporarily.
By the same token, the second quarter will see a temporary setback caused by disruption in supplies to the auto sector stemming from the Japanese earthquake and tsunami.
Overlooking those anomalies, the story hasn't changed much since January. The economy will keep growing, but moderately.
Given the weak dynamics, the bank gave no indication that it's anxious to start raising rates, even though in the past it has fretted that too low rates for too long could trigger inflation and unrestrained spending by Canadians. This time, the bank issues no such warning, and even speculates the housing market will slow.
The bank doesn't appear to be overly worried that high oil and food prices might trigger inflation.
Inflation is a problem globally, but in Canada the bank says it is not a concern, even though it expects inflation to spike to three per cent soon, at the upper end of the bank's acceptable range.
"The combination of modest growth in labour compensation (wages) and higher productivity is expected to continue to dampen inflationary pressures, with the higher assumed value of the Canadian dollar providing further restraint," the bank said the report.
Scotiabank economist Derek Holt found Carney's new outlook more dovish than expected, and stuck to his prediction the bank won't start hiking rates until October.
Part of the reason the bank can wait longer, said economist Michael Gregory of BMO Capital Markets, is that the dollar is doing the job of higher interest rates to dampen inflation.
"The loonie's flight plan now appears to be even more of a critical factor affecting the future timing and magnitude of policy rate hikes, but it won't prevent them," he added.
"Much will depend on how economic growth, inflation and the Canadian dollar perform in the quarters ahead."
The central bank does say that the economy will return to full capacity by the middle of 2012, earlier than it previously thought. That suggests Carney may want to see the policy rate move from the current one per cent to the more normal range of near three per cent by that time, Gregory noted.
Globally, the bank sees little change in the economic outlook, although it continues to stress risk factors such as high debt both among households and governments in the advanced economies, the Japanese crisis, turmoil in the Middle East and high commodity prices, especially oil.
"The global economic recovery is projected to proceed at a steady pace over 2011-13," the bank says, projecting growth of 4.1 per cent this year and 3.9 per cent next.
The bank has slightly lowered its forecast for U.S. growth this year to three per cent, from its previous 3.3 per cent call four months ago.
