OTTAWA, Ont. — Canada needs to start raising interest rates “without delay” and allow stimulus spending expire at the end of this year if it wants to avoid the risk of overheating the economy, according to leading international economic agency.
The blunt and somewhat surprising advice from the Organization for Economic Co-operation and Development comes at a time of growing uncertainty over the European debt crisis and financial market stability.
Yet the OECD is unequivocal, saying Canada’s economy will expand by 3.6 per cent this year and 3.2 per cent next year and no longer requires stimulation.
“The Bank of Canada should start normalizing its policy rate without delay and tighten gradually throughout the projection period (two years),” the OECD says.
“Governments should let remaining temporary stimulus measures expire to avoid overstimulating the economy.”
Further, it tells Ottawa and the provinces to flesh out how they plan cut spending to whittle down massive deficits built up during the recession.
One Canadian economist suggested that the OECD statement and forecasts of economic growth may have been compiled weeks ago when the world recovery looked more certain and robust.
“I have to wonder when this recommendation was cobbled together or if they would be so adamant today,” said Douglas Porter, deputy chief economist with BMO Capital Markets.
“From a domestic standpoint, there is no debate — the Bank of Canada should have been raising rates yesterday. But the reality is we do have the rumblings of what could be a serious global episode in financial markets.”
TD Bank economist Craig Alexander was also taken aback by the directness of the language, as if the OECD had no concerns about how European crisis would impact markets and the global economy.
The Paris-based agency’s growth projections are almost identical to what the Bank of Canada forecast in April, before European debt woes flattened global equity markets and sliced about seven per cent off the value of the loonie.
Since then, economists have said the central bank’s projections now appear rosy and that the risk of a double-dip slump in Europe and even the United States has arisen.
That would ripple in financial markets, again squeeze credit and likely impact Canada through lower demand and prices for commodities, much as happened in the fall of 2008.
Canada’s strong domestic fundamentals would shelter the economy somewhat, but few doubt the country’s recovery would be negatively impacted from the fallout.
Until recently, markets had “priced in” a 25 basis point hike to the policy interest rate on June 1, bringing the overnight rate to 0.50 per cent, still an extremely low level.
But economists say the odds have shifted to more than even that bank governor Mark Carney will wait until at least July 20, giving him time to assess the seriousness of the European situation.
Although underlying inflation is relatively robust for this early in the recovery cycle at 1.9 per cent, there is little evidence price pressures are poised to get out of control, said Alexander.
On the other hand there are plenty of reasons to proceed with caution.
“Quite frankly the global economy doesn’t look like it’s going to be booming,” Alexander said. “There are lots of risks related to the U.S. recovery, it’s very clear Europe is going to be materially weaker, the global financial system is trying to assess sovereign debt risk in Europe — all of this would suggest the Bank of Canada doesn’t have to be in a huge rush.”
The pressure on Carney may be one of perception, given that in April he signalled a readiness to move off the emergency low rate. But Alexander said markets would understand if Carney stands still for another six weeks, given the changed circumstances.