The recession in Canada may be over, but a new report from CIBC World Markets warns that a weak recovery will prevent the Bank of Canada from hiking interest rates until 2011.

The report by CIBC chief economist Avery Shenfeld says economic growth and inflation will remain muted next year.

“Unlike the Bank of Canada, we don’t expect growth to average above the non-inflationary potential until 2011,” says Shenfeld. “But even under Governor Carney’s more optimistic trajectory, inflation will still be feeling the downward pressure of a sizeable output gap next year, one as large as we saw in the early 1980s and 1990s downturns.”

The core inflation rate did not decelerate as much as the Bank of Canada predicted earlier this year, but Shenfeld says there are reasons to expect a further easing in core inflation ahead.

He points out that the Bank of Canada’s core CPI inflation measure excludes volatile items such as gasoline prices, which have been deflating.

“A look at the underlying components for headline and core inflation helps identify what has, in our view temporarily, prevented core inflation from easing much thus far,” Shenfeld says.

He notes that economic slack usually takes time in having disinflationary impacts, and expects the upward pressure on prices to ease in the coming months.

“Headline inflation rates won’t be as benign as they have been,” says Shenfeld, adding that a strong Canadian dollar will also provide a dampening impact on retail prices for imported goods and services.

With inflation likely to remain well under the Bank of Canada’s 2% target, Shenfeld says the Bank of Canada will face no pressure to waver on its pledge to keep interest rates at their low quarter-point level through mid-2010. He says the central bank could wait until the first half of 2011 to raise rates.

The CIBC report adds a recovery of the U.S. economy is on the horizon, and calls for third quarter growth that could top 3%. But it warns that the Canadian economy is unlikely to benefit from the return to growth south of the border. The nature of the U.S. recovery will be very different than in past recessions, since it will be driven by government stimulus rather than consumer spending, according to the report.

“The new American consumer is a shadow of his former self,” says the report. “Deleveraging and rising saving rates, along with a still weak labour market, suggest that consumer spending will contribute a mere 0.4 percentage points to 2010 growth, while at the same time hundreds of billions in fiscal stimulus dollars should boost 2010 real GDP growth by double that amount.”

In addition, protectionist trade barriers and a tilt in U.S. stimulus spending towards industries that have less-than-average propensities to import from Canada will dampen the benefits that this country typically sees from economic growth south of the border, the report says.

IE