IMF tells central bank to delay rate hikes

The International Monetary Fund is telling the Bank of Canada to hold off on interest rate hikes until the economy improves, and not to discount the need for cutting should a shock occur.

The IMF’s latest report on Canada, issued Wednesday, paints a picture of an economy that is doing reasonably well in the face of global headwinds, but also one that is vulnerable to external shocks.

It notes the recovery’s cruising speed has slowed this year and will likely underperform next year to slightly below two per cent.

The report’s good news is that it expects the pace to pick up to slightly above potential in the second half of 2013 and to continue in 2014 with an advance of about 2.25 per cent. That is in line with many Canadian private sector economists, including the CIBC, which on Wednesday forecast Canadian growth next year at a tepid 1.7 per cent, followed by 2.5 per cent in 2014.

The projections are what economists call “baseline scenarios,” which means the most likely to come true. Normally, the baseline scenarios are evenly bracketed by both downside and upside risks.

The trouble in this environment, says the IMF, is that the risks are all “tilted to the downside,” citing European’s ongoing problems and the still real changes of a budget crisis in the United States.

“In this context, the main challenge for Canada’s policy-makers is to support growth in the short term while reducing the vulnerabilities that may arise from external shocks and domestic imbalances,” the IMF said.

“The beginning of the monetary tightening cycle should be delayed until growth strengthens again,” adding that likely will come only late in 2013. But it could go the other way, the IMF warns.

“On the other hand, there is some space for further monetary easing if the economy were to weaken significantly.”

CIBC chief economist Avery Shenfeld said in his view the Canadian central bank is unlikely to act until 2014, and then only with caution, nudging rates up between half and three-quarters of a point.

TheIMFhadsimilaradviceforCanada’s government, saying they should keep on their deficit-reducing track but prepare to reverse course.

“If the economy weakened further, the federal and some provincial governments should allow the full operation of automatic stabilizers,” such as employment insurance support, it recommends. “In the event of a large adverse shock, the federal authorities could also consider a new temporary stimulus package.”

The IMF and the CIBC diagnose the economy in much the same way. Global weakness and a strong loonie continue to weigh down exporters, one of Canada’s most important sectors.