Bank of Canada slashes growth forecast

The Canadian economy grew at a slower-than-expected pace of 1.5 per cent in the second quarter, the Bank of Canada estimated Wednesday as it slashed an earlier forecast that looked for growth of two per cent.

However, the central bank said it expected the domestic economy will grow slightly faster in the second half of the year than thought earlier, logging overall annual growth of 2.8 per cent for 2011, down slightly from an earlier estimate of 2.9 per cent.

The latest outlook comes amid a growing credit crisis in Europe that the central bank identified as a growing risk.

“Although the global outlook remains broadly unchanged, global risks have intensified, most notably in Europe,” the Bank of Canada said in its July monetary policy report.

The bank warned the sovereign debt troubles in Europe could spark a credit crisis around the world.

The slower than expected growth in the April-to-June quarter was due in part to the end of government stimulus spending, as well as higher food and energy prices that crimped consumer spending in Canada and the U.S. Added to that was the global economic fallout from the earthquake and tsunami in Japan that disrupted manufacturing supply chains.

“The bank now estimates that these supply disruptions will subtract roughly three-quarters of a percentage point from GDP growth in Canada in the second quarter, a slightly larger impact than projected in the April report,” the Bank of Canada said.

The outlook by the Bank of Canada followed its decision Tuesday to keep the overnight rate target at one per cent. However, the central bank hinted that as the Canadian economy continues to grow, it will look to raise the rate, which affects prime lending rates at Canada’s big banks and in turn variable-rate mortgages, lines of credit and other loans.

Economists have speculated that the bank’s next rate hike will come in October at the earliest and almost certainly before the end of the year.

The bank noted that its projections Wednesday included “a gradual reduction in monetary stimulus over the projection horizon.”

Economic growth in Canada is expected to be driven by business investment and to a lesser extent consumer spending, while export growth will continue to be challenged by the persistent strength of the Canadian dollar, the bank said.

“The expected recovery in Canadian exports over the medium term is now projected to be even more muted than in the April report, reflecting negative revisions to the projected pace of U.S. demand growth,” the bank said.

The bank downgraded its expectations for the U.S. economy — Canada’s largest export market — to 2.4 per cent growth for this year compared with an earlier estimate of three per cent in April.

Meanwhile, inflation is expected come off its recent highs of more than three per cent — due in part to energy prices and the effects of the introduction of the HST in Ontario and B.C. last summer — to around two per cent by the middle of 2012, the central bank predicted.

The bank noted in its report that core inflation, which excludes some volatile items, is expected to rise slightly above two per cent for a short time, but remain around two per cent over its projection horizon.

Canada’s annual inflation rate in May reached its highest level in eight years, hitting 3.7 per cent on the back of big increases in gasoline prices. However, core inflation rose only moderately to 1.8 per cent.

Statistics Canada is expected to report June inflation data on Friday.

In identifying the risks to its outlook in addition to Europe, the bank warned that the strong Canadian dollar could create even greater headwinds for the economy and high household debt could weaken consumer spending.

But as Europe and the United States continue to put up warning signs, the Canadian economy has appeared to be on track with three consecutive months of job growth and signs of inflation.

The bank noted that commodity prices and global inflation could rise faster than expected to push domestic prices even higher, and household spending could also top expectations.