* Domestic challenges not unique -Bank of Canada's Murray
* Global experience helps explain inflation, exports
* Sees inflation rate dipping again in February
* Australia is evidence soft landing possible for housing
By Jennifer Kwan
VICTORIA, British Columbia, March 6 Canadian
exports were unexpectedly weak over the past two years, partly
due to U.S. budget cuts and the expiration of tax breaks known
as the "fiscal cliff," that took effect early last year, a
senior Bank of Canada official said.
Deputy Governor John Murray said in a speech on Thursday
that lackluster Canadian economic growth and three puzzling
trends - weak inflation, investment and exports - could be
partly explained by international factors.
He also pointed to Australia as evidence supporting the
central bank's forecast for a soft landing for the Canadian
With respect to exports, there has been an apparent
disconnect between foreign demand, particularly in the United
States, and the performance of Canadian non-commodity exports.
This has surprised policymakers, but Murray said recent
evidence suggests exports rely more heavily than thought on
demand from U.S. governments at the federal, state and local
level, with about 12 percent of non-commodity exports from 1997
to 2012 going to the U.S. government sector.
By recognizing that, and incorporating it into the bank's
measure of foreign activity, the bank is better able to
understand how exports behave, he argued.
"It relates to the fiscal cliff in the United States and the
significant budget consolidation that has been underway there in
the past two years," Murray said in his last public speech
before retiring on April 30.
The fiscal cliff refers to expiring U.S. tax breaks and
spending cuts from Jan. 1, 2013, which had the potential of
pushing the U.S., Canada's biggest trading partner, back into
recession in the absence of an alternative deficit-reducing
Murray stressed that the alternative explanation was not the
only cause of weak exports and warranted further investigation.
Canada emerged relatively unscathed from the global
financial crisis but its economy has failed to grow fast enough
to merit a return to normal monetary policy. The government and
central bank are trying to figure out how to lift growth without
relying on indebted consumers.
The Bank of Canada has held its benchmark rate at 1.0
percent for over three years. On Wednesday, it left the rate
unchanged again and reiterated its neutral stance. Analysts are
predicting a rate hike in the third quarter of next year.
DISINFLATION A CONCERN
In addition to scratching their heads over the lagging
exports in Canada, central bank officials have had trouble
understanding why inflation has stayed below the bank's
2-percent target for so long and why business investment has not
bounced back as expected after the 2008-09 recession.
These trends are international too and better understood
when seen in that context, Murray said.
"While it is important to interpret with caution what you
see through the international lens, we have seen how it can help
us resolve domestic economic puzzles and guide policy."
For example, Canada has learned from other countries that
the effect of output gaps on inflation has a longer lag than
previously thought, when these gaps are large and persistent.
He warned against getting too excited over a pickup in the
inflation rate in January to a 1-1/2-year high of 1.5 percent,
predicting the number would go down again in February because of
the effects of price increases a year earlier in automobiles and
"So we're still dealing with a situation, which (is)
Canada's inflation is weak and because of where it is relative
to our target, it remains a concern," he said.
With regards to business investment, another laggard, U.S.
researchers have shown that uncertainty is making companies shy
away from new projects.
The world beyond Canada also provides possible scenarios,
good and bad, for the country's heated housing market and
record-high household debt.
It would be a mistake to assume Canada is inevitably headed
for a crash, Murray said, even though its debt and housing
prices are comparable to those in the U.S. and Britain before
their respective crises.
"International evidence also provides some support for this
more benign scenario," he said. "Countries such as Australia
have managed a soft landing and the preconditions for this, one
could argue, are even more favorable in Canada.