TORONTO - The Bank of Canada is unlikely to hike interest rates until 2011 because the lingering effects of the global economic meltdown will continue to mute both growth and inflation, according to a report issued Tuesday by CIBC World Markets.
"While the 2009 recession may already be over, the slack it created is both large and likely to persist," said CIBC chief economist Avery Shenfeld.
"Unlike the Bank of Canada, we don't expect growth to average above the non-inflationary potential until 2011," Shenfeld added.
"But even under (Bank of Canada) Governor (Mark) Carney's more optimistic trajectory, inflation will still be feeling the downward pressure of a sizable output gap next year, one as large as we saw in the early 1980s and 1990s downturns."
He predicted both headline and core prices would cross paths in the second quarter of 2010, at a level well under the Bank of Canada's two per cent target.
"As a result, Canada's inflation rate will be no threat to the bank easily fulfilling its pledge to keep interest rates at a slim quarter point through mid-2010," he said. "In fact, market expectations for rate hikes in the first half of 2010 could be a full year too premature."
While the core inflation rate did not decelerate as much as the Bank of Canada predicted earlier this year, there are reasons to expect a further easing in core inflation ahead, Shenfeld said, including "what economists call the income effect."
Shenfeld notes that by stripping out volatile items from the CPI, the Bank of Canada's core measure now excludes most of the items that have been deflating.
With the volatile measures included, headline CPI is negative, largely driven by the dive in gasoline prices from a year ago. Lower gas prices have pulled down costs for intercity transportation fares as well, which the Bank of Canada also excludes from core inflation. Other non-core items such as natural gas, fuel oil and mortgage interest costs have also eased off.
"The deep dive in non-core items has left those Canadians still working with some spending power," Shenfeld said in explaining the income effect.
"While nominal wages have begun to decelerate in a slack labour market, a negative year-on-year inflation rate has meant that in real terms, the buying power of the average wage has escalated."
"So after filling their gas tank and paying their new, lower, mortgage bills, Canadians simply have more money in their pockets when they go shopping for other items, keeping those prices aloft."
Shenfeld notes that economic slack usually takes time to exert its disinflationary force and believes the upward pressure on prices will ease in the coming months.
Meanwhile, less benign headline inflation expected next year "implies diminished buying power for other goods, contributing to a cooling in core CPI."
"With a lag, a strong Canadian dollar will also provide a dampening impact on retail prices for imported goods and services."
Meanwhile, unlike the central bank's outlook, the CIBC report does not see the Canadian economy gaining much benefit from a forecasted U.S. recovery.
CIBC's analysis finds that protectionist trade barriers and a tilt in U.S. stimulus spending towards industries that have less-than-average propensities to import from Canada, will dampen the benefits that this country typically sees from economic growth south of the border.