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The federal government spending cuts will delay economic recovery and prompt the Bank of Canada to keep interest rates on hold at current low levels until late 2014, the parliamentary budget watchdog said on Wednesday.
In its semi-annual report to Parliament, the office of Parliamentary Budget Officer (PBO) Kevin Page also said that the spending cuts would eliminate the government's structural budget deficit by 2013-14.
A structural deficit is that portion of a deficit that is not the result of changes in the economic cycle, and that exists even when the economy is performing at its peak.
Last month's federal budget pledged to cut discretionary spending by 6.9 percent by 2014-15. The PBO report said this would delay the economy's return to operating at its full potential.
"PBO expects that restraint and reductions in government spending on programs in Canada will act as a drag on economic growth and job creation, pushing the economy further away from its potential GDP (gross domestic product) and delaying the economic recovery," the report said.
It forecast real economic growth of 1.9 percent this year and 1.6 percent in 2013. By comparison, the Bank of Canada sees growth of 2.4 percent this year and next, and the government's budget sees growth of 2.1 percent in 2012 and 2.4 percent in 2013.
The budget office estimated that the economy is running at 1.9 percent below its potential. The Bank of Canada estimates it was roughly half a percent below capacity in the first quarter and that the gap should vanish by the first half of 2013.
"Owing to the tepid pace of economic recovery and given the firm anchoring of inflation expectations, PBO expects the Bank of Canada to maintain its policy interest rate at 1 percent until the fourth quarter of 2014," the PBO report said.
The central bank held its key overnight rate at 1 percent last week but said that in light of the reduced slack of the economy and firmer underlying inflation, "some modest withdrawal of... monetary policy stimulus may become appropriate".
The PBO report forecast federal deficits of $20.4 billion in 2012-13, $13.4 billion in 2013-14 and $4.8 billion in 2014-15. It sees surpluses of $2.4 billion in 2015-16 and $10.8 billion in 2016-17.