Thank you very much.
Good afternoon, Mr. Chairman and committee members. Senior Deputy Governor Wilkins and I are pleased to be with you today to discuss the bank's monetary policy report, which we published just last week.
At the time of our last appearance in October, we saw signs that the Canadian economy was moderating after an exceptionally strong first half of the year. Now that moderation turned out to be greater and to last a bit longer than we expected at the time. Still, it's important to recognize that inflation is on target and that the economy is operating close to potential.
Now that statement alone underscores the considerable progress seen in the economy over the past year. The slower than expected growth in the first quarter just passed reflected two main issues.
First, housing markets reacted to announcements of new mortgage guidelines and other policy measures by pulling forward some transactions into the fourth quarter of last year. That led to a slowdown in the first quarter that should naturally reverse.
Second, we saw weaker than expected exports during the first quarter. This weakness was caused in large part by various transportation bottlenecks. Some of this export weakness should also reverse as the year goes on. So, after a lacklustre start to 2018, we project a strong rebound in the second quarter. All told, we expect that the economy will grow by 2% this year, and at a rate slightly above its potential growth rate over the next three years, supported by both monetary and fiscal policies.
The composition of growth should shift over the period, with a decline in the contribution from household spending and a larger contribution from business investments and exports.
Inflation should remain somewhat above the 2% target this year, boosted by temporary factors. These factors include higher gasoline prices and increases to the minimum wage in some provinces. Their impact should naturally unwind over time, returning inflation to 2% in 2019.
Of course, this outlook is subject to several important risks, and a number of key uncertainties continue to cloud the future, as was the case in October.
The four main uncertainties around the outlook for inflation are the same as we mentioned six months ago, but good progress has been made on some of them.
First, in terms of economic potential, our annual review led us to conclude that the economy currently has more capacity than we previously thought. As well, this capacity is growing at a faster pace than we expected. This means that we have a little more room for economic demand to grow before inflationary pressures start to build. That said, some firms, particularly exporters, are operating at their capacity limits, but are hesitating to invest. This hesitation may be due to trade uncertainty, the transportation bottlenecks, shortages of skilled workers, or other reasons. Regardless, it is limiting growth of our exports and economic capacity.
The second source of uncertainty concerns the dynamics of inflation. Here, recent data have been reassuring. Inflation measures, including our various core measures, have been behaving very much as forecast, and they are consistent with an economy that is operating with very little slack. This gives us increased confidence that our inflation models are working well.
The third area of uncertainty concerns wages, and the data here are also all encouraging. Wage growth has picked up significantly over the past 18 months. It is now approaching the 3% growth rate that one would expect from an economy that's running at capacity. However, the most recent figures are being boosted temporarily by the minimum wage increases in some provinces.
The fourth source of uncertainty is the increased sensitivity of the economy to higher interest rates, given elevated levels of household debt. The concern is that as interest rates rise, the share of household income going to service debt will also rise. This will leave less to spend on other goods and services and put downward pressure on inflation. It will take more time for us to assess this issue, particularly because new mortgage guidelines are currently affecting the housing market and mortgage lending. However, the growth of household borrowing is slowing, which is consistent with the idea that consumers are starting to adjust to higher interest rates and new mortgage rules.
As you can see, there has been some progress on these four key areas of uncertainty in the economy, particularly the dynamics of inflation and wage growth. This progress reinforces our view that higher interest rates will be warranted over time, although some degree of monetary policy accommodation will likely still be needed to keep inflation on target. The bank will continue to monitor the economy's sensitivity to interest rate movements and the evolution of economic capacity. In this context, the governing council will remain cautious with respect to future policy adjustments, guided by incoming data.
With that, Mr. Chairman, Senior Deputy Governor Wilkins and I would be happy to answer your questions.