Trade and uncertainty weigh on economy, Bank of Canada deputy governor says

The Canadian economy has shaken off the weakness seen at the start of the year, but escalating trade conflicts and related uncertainty are taking a toll, a senior Bank of Canada official said Thursday.

In a speech in Halifax, deputy governor Lawrence Schembri said the Canadian economy has rebounded from its earlier soft patch, but the economic data shows some areas of concern.

Schembri said the Canadian economy is operating close to full potential with low unemployment and inflation right on the central bank’s target.

“This solid starting point means the economy has a welcome degree of resilience to possible negative economic developments,” he told the Halifax Regional Chamber of Commerce according to prepared remarks released in Ottawa.

“That said, we agree that the data show some areas of concern. Among these is the weakness in consumption … and, of course, we are concerned about the drop in business investment, which is likely linked to ongoing trade war and related uncertainty.”

The Bank of Canada kept its key interest rate target on hold on Wednesday, but said it is keeping a watchful eye on the global economy. The central bank adjusts the rate in order to manage inflation. Many economists have predicted the bank will cut rates later this year.

The central bank’s wait-and-see approach this week came as other central banks around the world have been signalling or taking actual action, including interest rate cuts to respond to the trade risks and deteriorating global economy.

“In this uncertain environment, central banks have been conducting monetary policy appropriate to their own circumstances and outlooks. This has contributed to lower bond market yields and reduced borrowing costs in Canada,” Schembri said.

The deputy governor added at a news conference that the Bank of Canada has been accounting for trade issues in its economic forecasts for several years now.

“Initially it was NAFTA-related and more recently obviously it’s the U.S.-China trade war, but we’ve been including in our projection uncertainty effects on business investment and on exports in Canada,” he said.

“So if you look at our outlooks for the global economy and some important countries, they’ve generally been …. lower than other institutions.”

The U.S. and China have been locked in an escalating trade war, however the two sides are expected to meet in early October for talks aimed at ending the fight.

TD Bank senior economist Brian DePratto said Schembri went a bit further than the bank’s short statement Thursday, emphasizing both a perceived lack of economic slack and its implication for inflation.

“All this points to a central bank that doesn’t want to pull the trigger on easing until they see the proverbial ‘whites of their eyes’ of deteriorating domestic conditions,” DePratto wrote in a report.

“Given that consumption and investment weakness were called out both yesterday and today, developments in these areas will be key.”

The Canadian economy grew at an annual pace of 3.7 per cent in the second quarter, faster than the Bank of Canada expected. The growth was fuelled by rebounds in energy production and exports as well as strength in housing.

However, the bank has cautioned that some of the unexpected strength in the second quarter will likely prove to be temporary and predicted growth will slow in the second half of the year.

Schembri said that given Canada’s reliance on international trade, a trade war remains the central bank’s primary concern and the biggest risk in its forecast.

“Trade policy uncertainty has been weighing on business investment and exports for a couple of years now. And things could certainly get worse internationally, which would deliver a complex shock to our economy affecting both supply and demand,” he said.

The Bank of Canada’s next interest rate announcement is set for Oct. 30 when it will also update its economic forecast in its monetary policy report.