Dollar drops after Bank of Canada deputy says economy still needs stimulus

Canada's struggling economy still needs the extra boost of monetary stimulus to help keep the recovery on track, and it might take longer than expected to get there, Bank of Canada senior deputy governor Carolyn Wilkins said Monday.

She said "persistent headwinds" could mean that "some degree of stimulus" will be needed to keep inflation on target, even after the economy returns to full capacity.

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The Canadian dollar headed lower after her remarks, down 0.70 of a cent to 90.65 cents US.

Last week, the Bank of Canada said it would continue a hands-off approach regarding the loonie, saying that trying to interfere with the direction of the currency would hurt the bank's ability to pursue independent monetary policy.

But economists have suggested that bank governor Stephen Poloz's dovish talk on interest rates has helped take some of the shine off the loonie in a deliberate move to bolster exports.

New normal is low rates

In her first speech as the senior deputy governor, Wilkins said the neutral interest rate — the level at which the economy can be sustained at full capacity with stable inflation — has dropped to a range of three to four per cent, about 1.5 percentage points lower than before the economic downturn.

The lower estimate for the neutral rate means interest rates could be lower than they have been in the past when the economy is running at full steam.

The Bank of Canada has kept its key interest rate at one per cent for four years.

"It is clear that continued monetary stimulus is needed to return the Canadian economy to sustainable growth and to maintain inflation at target," Wilkins told an audience at the Toronto Region Board of Trade.

'Persistent headwinds' 

"Depending on the evolution of the data, it is possible that persistent headwinds will mean that some degree of stimulus will be required even after the output gap is closed to keep inflation at target."

Wilkins, who began a seven-year term in the senior deputy role in May, said potential output growth in Canada and other industrialized economies will be lower than it was in the years leading up to the financial crisis.

"Some of the headwinds appear to be dissipating, but there is considerable uncertainty about how long they will persist," she said.

Part of the challenge will come from within Canada, where "structural" factors like the aging workforce and slower growth in productivity levels may be affecting the speed of a recovery, Wilkins said.

Output growth potential sits at just below two per cent over the next two years, the bank predicts, which is lower than before the recession.

The Bank of Canada is scheduled to update its monetary policy report next month with the latest quarterly outlook.