In his opening statement before the Standing Senate Committee on Banking, Trade and Commerce, David Dodge, governor of the Bank of Canada, reiterated the central bank’s bullish view on the Canadian economy, and foreshadowed a succession of rate hikes.

Dodge affirmed that the Bank of Canada projects that, in the first half of 2002, the Canadian economy will grow by between 3.5% and 4.5% annual rates. “And we expect that it will continue to expand in the second half of the year and in 2003 at a rate somewhat above that of its production capacity (or potential), which we estimate to be around 3% a year.”

“Our economy is operating at a much higher level than we thought [it would]. So the output gap is smaller than we had predicted and is currently narrowing. Indeed, we expect that it will close in the second half of 2003,” said Dodge. “The output path that we are now projecting is consistent with core CPI inflation being at 2% by about the end of next year. Total CPI inflation will probably continue to fluctuate in coming months as oil and natural gas prices move around. But, like core inflation, we expect it to be at the 2% target midpoint by about the end of 2003.”

He said that while uncertainty is less than it was six months ago, there are still risks to the outlook, on both the upside and downside. “Given the amount of monetary and fiscal stimulus in the economy, output growth could be even stronger than projected. But it is also possible that some of the recent strength in spending on consumer durables was borrowed from the future, so that the growth of household expenditures will be weaker than expected. At the same time, there is still considerable uncertainty about the timing and strength of the pickup in business investment in North America, mainly because of the continued weakness in profits. Moreover, recent tensions in the Middle East could have implications for crude oil prices and the global economy.”

Future rate hikes seem a certainty. “In these circumstances, our job will be to gauge the strength of the economy as it approaches its capacity to produce and reduce the amount of monetary stimulus in place in a timely and measured manner. We want to ensure that inflation stays close to the target so that, over the medium term, our economy can continue to grow at full capacity.”

He noted that the Bank must be forward-looking because its rate actions take a year to 18 months to have their full effect on output, and 18 months to 2 years to have their full effect on inflation. “Over the past year we put our foot on the gas to help us get up the hill of economic difficulties. The prudent thing now, as we return to more normal driving conditions, is to ease off on the gas – ease off, not slam on the brakes – to make sure that we continue our journey along the highway at a safe cruising speed.”