By Louise Egan
OTTAWA Feb 3 The International Monetary Fund
(IMF) said Monday Canada's central bank is likely to hold its
main interest rate steady until early 2015, and the bank has
limited room to cut rates because of overvalued housing prices
and record household debt.
After consultations with Canadian officials on the state of
the economy, completed in late January, the IMF concluded the
Canadian economy will pick up speed in 2014 as exports get a
lift from stronger U.S. growth.
It highlighted concerns that growth remains too reliant on
consumer spending and homebuilding, but it sees exports and
business investment gradually taking over as the main drivers of
growth over the next couple of years.
"Monetary policy should remain accommodative until there are
firmer signs that growth is picking up above potential, with a
sustainable transition from household spending to exports and
business investment," the Washington, D.C.-based lender said in
The IMF's projections assume the Bank of Canada's overnight
target rate will start increasing in "early 2015" and rise to 4
percent by 2019. Analysts in a Reuters poll conducted just
before the bank's Jan. 22 rate announcement predicted the bank's
first rate increase would come in the second quarter of 2015.
The bank has kept rates at 1.0 percent since September 2010,
but last month it revealed a growing concern about chronically
weak inflation, prompting some market players to increase their
bets on a rate cut at some point this year.
While the IMF acknowledged a recent cooling of the housing
market and household debt, it warned that these problems could
flare up again if the bank eases policy.
"The existence of domestic imbalances, however, reduces the
room for lowering the policy rate despite the recent moderation
in the housing sector and household borrowing," it said.
The IMF sees inflation returning to the central bank's 2
percent target by the end of 2015, roughly in line with the
Average house prices in the country are still overvalued by
10 percent, the IMF estimated, saying prices were high relative
to income and rents, compared with historical averages, and
compared with prices in many other advanced economies.
As a long-term goal, it urged Ottawa to reduce its exposure
to mortgage insurance through the government-owned Canada
Mortgage and Housing Corp (CMHC), stressing that this process
should be gradual to avoid market disruption.
The federal government guarantees 100 percent of CMHC's
insured loans, and CMHC has a 75 percent share of the mortgage
insurance market in the country.
A separate IMF report assessing the stability of Canada's
financial system, also released on Monday, identified mortgages
and consumer loans secured by real estate as the single largest
source of exposure for banks.
The IMF sees the Canadian economy growing by 1.7 percent in
2013, rising to 2.2 percent in 2014. The Bank of Canada's 2014
growth forecast is a slightly higher at 2.5 percent.
WEAKER C$ AND EXPORTS
The IMF suggested the recent depreciation of the Canadian
dollar against the U.S. dollar had not given the lift to exports
that it normally would.
"In particular, despite the depreciating exchange rate,
non-energy exports remained well below the levels reached after
earlier recessions," it said.
The Canadian dollar has fallen sharply since the central
bank adopted a more dovish tone last October, and it hit a
4-1/2-year low last week.
The IMF report looked at the depreciation relative to a
basket of other currencies and said the Canadian dollar was 10
percent overvalued, on average, in the first 10 months of 2013.
Roberto Cardarelli, the IMF's mission chief to Canada, later
said on a conference call with journalists that the currency
fell by about 5 percent in 2013 overall in real, effective terms
and was still somewhat overvalued.
"It is moving in the right direction. Our 10 percent
overvaluation is probably right now a little bit lower," he
said. "I think what happened over the last two or three months
may have reduced the degree of overvaluation but not totally
It's too early to say what impact the weaker currency will
have on exports, he said, with stronger U.S. demand likely to be
the main driver of export growth.
A decade of a strong currency and low productivity rates may
have done long-lasting damage to the export sector.
"As you know, there are other headwinds that we think are
still at work, that are more structural in nature. This loss of
competitiveness, it's something that concerns us. It's something
that concerns the authorities as well," said Cardarelli.
The IMF also had some advice for Finance Minister Jim
Flaherty as he prepares to deliver the federal budget on Feb.
11. The lender applauded Ottawa's steps to eliminate the budget
deficit and sees it on track to achieve that in the 2015-16
fiscal year with little effort. It added, "there is room to
delay the adjustment needed to return to a balanced budget in
2015 if there is no meaningful pickup in economic growth."
Growth of less than 2 percent a year would be cause for
rethinking the timeline for balanced budgets, said Cardarelli.
The federal deficit is seen shrinking to 0.4 percent of
gross domestic product (GDP) in 2014 from 0.8 percent this year,
but when provincial government deficits are included, the gap is
3.1 percent of GDP this year and 2.6 percent in 2014.