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Highlights * Despite some lingering uncertainties on the global scene, developments since the May 1999 Monetary Policy Report have resulted in a firmer tone in the outlook for the world economy and for Canada. * The Canadian economy now appears poised to attain growth in 1999 towards the upper end of the 2 3/4 to 3 3/4 per cent range set out in the May Report. * Trend inflation is still expected to edge up but to remain in the lower half of the Bank's inflation-control target range of 1 to 3 per cent. Information received since early July, when the update to the Monetary Policy Report was completed, continues to point to a generally firmer tone in the outlook for the world economy and for Canada. Nonetheless, lingering uncertainties on the global scene bear watching. In Japan, there are signs that the protracted economic recession may be coming to an end. In Europe, expectations of a pickup in the pace of expansion as the year progresses are becoming more widely held. Economic and financial conditions remain generally positive in those emerging-market economies in Southeast Asia and Latin America that are vigorously pursuing sound domestic policies. In the United States, real GDP rose by an estimated 2.3 per cent in the second quarter—below most expectations. A significant part of the slowdown, however, was attributable to a major inventory adjustment. Growth of real final domestic demand also decelerated, but remained strong at just under 4 per cent, following growth of over 6 per cent in the two previous quarters. Overall, the U.S. economy continues to operate at high levels, thereby heightening concerns about potential inflationary pressures. While inflation at both the retail and producer-price levels appears to be contained, with tight labour markets (employment was up strongly in July) signs of cost pressures have emerged recently, reflecting rising rates of labour compensation and slowing productivity growth. Here in Canada, indicators of domestic demand such as retail and wholesale trade, motor vehicle sales, housing activity, imports, and business investment plans all support a picture of solid expansion through the spring and summer months. Exports, after several quarters of very strong growth, remain at high levels, and economy-wide production data (e.g., monthly GDP at factor cost) through May also indicate a steady, solid pace of expansion. Moreover, world commodity prices have risen somewhat further recently, providing support to Canada’s resource sector. The prices of some key primary commodities produced in Canada (especially energy and base metals) have been among the fastest rising. And as anticipated, there was renewed employment growth in July, notably in full-time, paid jobs. On balance, recent data suggest that real GDP increased by about 3 1/2 per cent (annual rate) in the second quarter—broadly in line with expectations at the time of the July update. The 12-month rate of increase in the core CPI edged up to 1.7 per cent in June. As in the previous two months, the June increase was slightly higher than expected. This is partly because of the more rapid pass-through of the earlier exchange rate depreciation into retail prices. However, with slack still present in the economy, core inflation is expected to remain close to current levels, below the midpoint of the Bank’s 1 to 3 per cent target range, through the balance of 1999. Uncertainty about inflationary pressures in the United States and the possible implications for the stance of U.S. monetary policy, as well as shifts in international investment portfolios (encouraged by improving economic conditions overseas), have resulted in significant movements in financial markets in recent weeks. In July, the U.S. dollar weakened markedly against both the yen and the euro. While the Canadian dollar was softer against its U.S. counterpart for much of the last month, it has strengthened recently, supported by Canada’s low inflation and solid economic expansion and by firmer world commodity prices. Interest rates in Canada remain below those in the United States across all maturities, although the differentials have narrowed since early July.

While inflation has come off its peak, it remains too high. As the economy responds to higher interest rates and as the effects of elevated commodity prices and supply disruptions fade, the Bank expects inflation to fall to about 3% in late 2023, then return to 2% in 2024.

The resurgence of sizable current account imbalances in the major economies in recent years, particularly the tripling of the U.S. deficit, has led to renewed academic and public discussions about their sustainability. Jacob's main objective is to show that current account balances are simply the outcome of various relative structural and cyclical forces between trading partners. He reviews the factors behind the changes in the current account positions of the three largest industrial economies (the United States, Japan, and the euro area). Two strong determinants shaping the current account balances are the faster increase in U.S. productivity compared with that of other major economies and, more recently, the loosening in the U.S. fiscal stance. Jacob also reviews a range of outside assessments from such sources as the Organisation for Economic Co-operation and Development and the International Monetary Fund, as well as the academic literature, to determine the possible risks to macroeconomic and financial stability.

As the title of the conference suggests, we have seen many boom-and-bust cycles in the commodity sector. This raises one obvious and central question: How can we avoid them in the future?

Today, I want to focus my remarks on Canada's adjustment to changes in the global economy. I will talk about our efforts to adjust to longer-term economic forces and about the challenges that these forces present. Some of our experiences may be relevant to other economies that are making similar adjustments in the face of similar economic circumstances.

In this issue of the Financial System Review, the Bank of Canada’s Governing Council judges that, although the Canadian finan­cial system is currently on a sound footing, risks to its stability remain elevated and have edged higher since December 2010.

Senior Deputy Governor Carolyn A. Wilkins discusses three areas in which work remains to be done to improve financial stability.

In the last half-year, the economic expansion in Canada has become well established, supported by low inflation, highly stimulative monetary conditions, and a strong U.S. economy.

The Bank of Canada's commitment is to contribute to the economic well-being of Canadians. This means conducting monetary policy so that it fosters sustained economic growth - by creating conditions that favour rising output, employment, and incomes, and a stable macroeconomic environment.

This is a report of the Governing Council of the Bank of Canada: Mark Carney, Tiff Macklem, John Murray, Timothy Lane, Jean Boivin and Agathe Côté. It presents the Bank’s outlook based on data received up to 8 April 2011.