Canada’s central bank left it key interest rate steady for the 9th time but will scale back its asset purchases, as signaled last month, as it becomes the first developed market central bank to roll back the extraordinary level of monetary stimulus in response to the global economic recovery from the COVID-19 pandemic.
The Bank of Canada (BOC) kept its target for the overnight rate at 0.25 percent, unchanged since March 27, 2020 when it was cut for the third time that month to what the bank considers the effective lower bound.
It also left the bank rate at 0.50 percent and the deposit rate at 0.25 percent.
”The outlook has improved for both the global and Canadian economies,” BOC said, adding economic activity has proved more resilient than expected in the face of the pandemic and the rollout of vaccines.
In addition to trimming its weekly purchases of government bonds to $3 billion from $4 billion, BOC raised its forecast for economic growth and inflation, and pulled forward its date for when it may raise its interest rate.
”We remain committed to holding the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved,” BOC said, reiterating its previous guidance, but then adding:
”Based on the Bank’s latest projection, this is now expected to happen some time in the second half of 2022,” a change from the January projection that saw this happening in 2023.
BOC was very aggressive in easing its monetary policy stance last year in response to the pandemic.
The bank not only slashed its key interest rate three times in the month of March by a total of 150 basis points to what it saw as the effective lower bound of 0.25 percent, but also embarked on asset purchases of both commercial paper and government bonds to ensure financial markets continued to operate.
Initially, BOC began buying C$5 billion of government securities a week and then in the following month of April last year the bank expanded the program to include up to $50 billion of bonds from the country’s provinces and up to $10 billion in corporate bonds.
In October last year BOC’s weekly bond purchases were trimmed to $4 billion as part of a shift toward buying more longer-term bonds that have a more direct impact on borrowing rates.
The result of last year’s asset purchases and repurchase operations was BOC’s balance sheet ballooned four times its pre-pandemic size to about $575 billion in February.
But in a key speech last month by BOC Deputy Governor Toni Gravelle about the bank’s move to discontinue some of its crises programs – foreshadowing today’s move – he said some of the shorter-term debt bought by the bank had already matured and by the end of April the balance sheet will have shrunk to about $475 billion.
Although Canada has weathered the economic storm from the pandemic better than expected, the bank said a number of regions were experiencing a third wave of infections and lockdowns, injecting a new dimension of uncertainty, and the recovery remains highly dependent on the virus and vaccinations.
“Even as economic prospects improve, the Governing Council judges that there is still considerable excess capacity, and the recovery continues to require extraordinary monetary policy support,” BOC said.
Decisions about further changes to the bank’s purchases of assets – known as quantitative easing (QE) – will be guided by how the recovery proceeds and the bank said it would continue with QE to keep interest rates low across the yield curve and to provide “the appropriate degree of monetary stimulus to support the recovery and achieve the inflation objective.”
After shrinking in the first and second quarters of 2020, Canada’s economy has bounced back, with gross domestic product growing 8.9 percent in the third quarter from the second quarter and then 2.3 percent in the fourth quarter of last year for an annual contraction of 3.2 percent, up from 5.3 percent in the third quarter and 12.7 percent in the second quarter of 2020.
Growth in the first quarter of this year appears “considerably stronger” than the bank forecast in January and it now expects slack in the economy to be absorbed and inflation to sustainably return to its target of 2.0 percent, within a control range of 1-3 percent, in the second half of 2022.
BOC raised its forecast for growth this year to 6.5 percent, up from January’s forecast of 4 percent and a 2.5 percent contraction in 2020.
For 2022 the economy is seen expanding around 3.75 percent, down from its earlier forecast of 5 percent, and then 3.25 percent in 2023, up from 2.5 percent.
Earlier today there was further proof of Canada’s recovery from the pandemic, with Statistics Canada saying the annual inflation rate rose to 2.2 percent from 1.1 percent in February, continuing the steady rise since June 2020 when consumer prices rose after deflation set in during April and May.
Over the next few months, inflation is expected to rise temporarily to the top of the bank’s control range, mainly due to base effects, but then return to 2 percent in the second half of next year.
Inflation is forecast to rise to 2.2 percent in the fourth quarter of this year, up from January’s forecast of 1.5 percent but down from 2.9 percent in the second quarter, and then ease to 2.0 percent a year later before rising to 2.4 percent in the fourth quarter of 2023, up from 2.1 percent.
Canada’s labor market has been strengthening faster than expected, with the economy in March adding three times the number of jobs as expected, pushing down the unemployment rate to 7.5 percent that month from 8.2 percent in February and down from a pandemic high of 13.7 percent in May 2020.
BOC also revised upward its estimate of the country’s potential output due to the country’s greater resilience to the pandemic and accelerated digitalization though it remains 1 percent below pre-pandemic estimates.
Global potential output is forecast to recovery to 3.0 percent in 2022 and 2023, up from 2.7 percent this yea and 2.3 percent in 2020 as the impact of the pandemic fades, and Canada’s potential output is forecast to rebound to 1.6 percent in 2022 from an earlier forecast of 1.5 percent – including the temporary effects of the pandemic – and 2.0 percent in 2023.
The yield on Canada’s benchmark 10-year government bond has also recovered steadily since hitting a low of around 0.40 percent in August last year to trade around 1.5 percent in the last month.
The Canadian dollar reacted strongly to the BOC’s move, jumping some 1.3 percent to 1.248 to the U.S. dollar, continuing its steady rise since almost hitting records low of 1.45 against the U.S. dollar in March last year to be up over 2 percent this year.
The Bank of Canada issued the following statement:
“The Bank of Canada today held its target for the overnight rate at the effective lower bound of ¼ percent, with the Bank Rate at ½ percent and the deposit rate at ¼ percent. The Bank continues to provide extraordinary forward guidance on the path for the overnight rate, reinforced and supplemented by the Bank’s quantitative easing (QE) program. Effective the week of April 26, weekly net purchases of Government of Canada bonds will be adjusted to a target of $3 billion. This adjustment to the amount of incremental stimulus being added each week reflects the progress made in the economic recovery.
The outlook has improved for both the global and Canadian economies. Activity has proven more resilient than expected in the face of the COVID-19 pandemic, and the rollout of vaccines is progressing. A number of regions, including Canada, are experiencing a difficult third wave of infections and lockdowns. The more contagious variants of the virus are straining healthcare systems and affecting hard-to-distance activities, and have introduced a new dimension of uncertainty. The recovery remains highly dependent on the evolution of the pandemic and the pace of vaccinations.
Global economic growth is stronger than was forecast in the January Monetary Policy Report (MPR), although the pace varies considerably across countries. After a contraction of 2 ½ percent in 2020, the Bank now projects global GDP to grow by just over 6 ¾ percent in 2021, about 4 percent in 2022, and almost 3 ½ percent in 2023. The recovery in the United States has been particularly strong, owing to fiscal stimulus and rapid vaccine rollouts. The global recovery has lifted commodity prices, including oil, contributing to the strength of the Canadian dollar.
In Canada, growth in the first quarter appears considerably stronger than the Bank’s January forecast, as households and companies adapted to the second wave and associated restrictions. Substantial job gains in February and March boosted employment. However, new lockdowns will pose another setback and the labour market remains difficult for many Canadians, especially low-wage workers, young people and women. As vaccines roll out and the economy reopens, consumption is expected to rebound strongly in the second half of this year and remain robust over the projection. Housing construction and resales are at historic highs, driven by the desire for more living space, low mortgage rates, and limited supply. The Bank will continue to monitor the potential risks associated with the rapid rise in house prices. Meanwhile, strong growth in foreign demand and higher commodity prices are expected to drive a robust recovery in exports and business investment. Additional federal and provincial fiscal stimulus will contribute importantly to growth. The Bank now forecasts real GDP growth of 6 ½ percent in 2021, moderating to around 3 ¾ percent in 2022 and 3 ¼ percent in 2023.
The Bank has revised up its estimate of potential output in light of greater resilience to the pandemic and accelerated digitalization. The virus and lockdowns have had very different impacts across sectors, businesses, and groups of workers, creating an unusual degree of uncertainty about the amount of slack in the economy and how long it will take to be absorbed. To gauge the evolution of slack, the Bank will look at a broad spectrum of indicators, including various measures of labour market conditions.
Over the next few months, inflation is expected to rise temporarily to around the top of the 1-3 percent inflation-control range. This is largely the result of base-year effects—year-over-year CPI inflation is higher because prices of some goods and services fell sharply at the start of the pandemic. In addition, the increase in oil prices since December has driven gasoline prices above their pre-pandemic levels. The Bank expects CPI inflation to ease back toward 2 percent over the second half of 2021 as these base-year effects diminish, and inflation is expected to ease further because of the ongoing drag from excess capacity. As slack is absorbed, inflation should return to 2 per cent on a sustained basis some time in the second half of 2022.
Even as economic prospects improve, the Governing Council judges that there is still considerable excess capacity, and the recovery continues to require extraordinary monetary policy support. We remain committed to holding the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved. Based on the Bank’s latest projection, this is now expected to happen some time in the second half of 2022. The Bank is continuing its QE program to reinforce this commitment and keep interest rates low across the yield curve. Decisions regarding further adjustments to the pace of net purchases will be guided by Governing Council’s ongoing assessment of the strength and durability of the recovery. We will continue to provide the appropriate degree of monetary policy stimulus to support the recovery and achieve the inflation objective.”
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