The Bank of Canada (BOC) said the negative impact of the decline in oil prices on economic activity was now appearing even sooner than it expected in January though looking at the next two years the overall drag on the economy will be the same.
The forecast for economic growth this year was trimmed to 1.9 percent from January's forecast of 2.1 percent, mainly because investments will be lower, but for 2016 the growth estimate was revised up to 2.5 percent from 2.4 percent as exports jump. For 2017 the BOC forecast 2.0 percent growth.
"The Canadian economy is estimated to have stalled in the first quarter of 2015," said the BOC, adding that the shift toward stronger non-energy exports, rising investment and improving labor markets was fueled by easier financial conditions and improving U.S. demand.
With the effects of the oil price shock waning, Canada's economic growth is projected to rebound in the second quarter of this year. In the fourth quarter of 2014 Gross Domestic Product rose an annual 2.63 percent.
The BOC's forecast for 2015 is more pessimistic than that from the International Monetary Fund, which this week cut its 2015 growth forecast to 2.2 percent from its January forecast of 2.3 percent. However, for 2016 the BOC is more optimistic as the IMF only forecast growth of 2.0 percent, down from its January forecast of 2.1 percent.
Exports from Canada's manufacturing sector - such as aircraft, machinery and pharmaceuticals - are benefitting from the decline in the Canadian dollar against the U.S. dollar. However, the flip side of a lower Canadian dollar is that it costs more to borrow in U.S. dollars, hitting investments.
The Canadian dollar, known as the loonie, tumbled against the U.S. dollar in the second half of last year, not only reflecting the strength of the U.S. economy, but also confirming the Canadian currency's historical relationship with oil prices.
In its monetary policy report, the BOC said the Canadian dollar was assumed to be close to its recent average level of 79 cents over the projection horizon compared with 86 cents assumed in January. Today the loonie was at 80 U.S. cents compared with 86 cents at the start of the year.
Weak economic activity in the first three months of this year has widened the economy's output gap, putting additional downward pressure on inflation. However, the expected recovery in growth means the output gap will be back in line with the forecast so the effect on core inflation from the lower dollar and the output gap will continue to offset each other, the BOC said.
In February Canada's headline inflation rate was unchanged at 1.0 percent but as the economy reaches full capacity around the end of 2016, the BOC expects total and core inflation to be close to its 2.0 percent target. Total consumer price inflation is forecast to reach 1.4 percent by the fourth quarter of this year and then 2.0 percent by the end of 2016.
The Bank of Canada issued the following statement: