Inflation will likely bottom out early next year, and the economy should grow at an annual rate of more than 4% in the final quarter of this year, David Dodge, Governor of the Bank of Canada, said Monday.

Speaking to the London Chamber of Commerce, Dodge said that the Bank expects that Canada’s inflation rate will fall over the next few months. He projected that the core rate of inflation will likely move down close to the bottom of its’ 1% to 3% inflation-control range early next year, before starting to move back up towards 2%.

He noted that the data for the third quarter showed that Canada’s economy had grown at an annualized rate of just 1.1% in the third quarter, a rate that was well below expectations. “What’s more, there were downward revisions to growth in previous quarters. This meant that, at the end of the third quarter, there was more excess capacity in the Canadian economy than we had anticipated,” he said.

“In the Monetary Policy Report, we said that we expected the economy to close its output gap and return to its level of full capacity by early 2005. Closing the output gap over that period would be consistent with inflation returning to the 2% target by mid-2005. But because we now know that the output gap is larger than we had expected in October, we also know that the economy will have to grow at a faster rate during the fourth quarter and through 2004 to close that output gap by early 2005,” Dodge noted.

Dodge said that, while growth earlier this year was disappointing, the Bank is now seeing a number of encouraging signs suggesting that stronger growth will resume, beginning in the current quarter. He pointed out that low growth numbers were partly due to an inventory work off, that domestic demand is growing impressively, the reduction in inventory investment is probably over, and that Canada’s export sector should receive a boost from rising foreign demand. “All told, the Canadian economy should be poised for solid growth ahead, beginning in the fourth quarter. We would expect economic growth in this quarter to be well above 4% on an annualized basis.”

“However—and let me stress this—the effect of the recent sharp appreciation of the Canadian dollar is a major uncertainty at this time. It is not clear to what extent the increase in foreign demand I have just mentioned will be offset by the effects of a stronger currency. Nor can we be sure that there is enough monetary stimulus in the economy to support the increases in household spending and business investment that would be required to return the economy to full capacity by early 2005,” Dodge said, opening the door to further rate cuts.

“Some important economic data are expected between now and our next fixed announcement date, on 20 January. These should give us a better sense of how Canada’s export sector is doing, and how household spending went over the holiday season. We will be closely watching all the data ahead for evidence that the economy is growing at a rate solidly above the growth of potential,” he concluded.