Bank of Canada expected to stand pat on rates, bond buying

Open this photo in gallery:

The Bank of Canada is expected to hold the line on monetary policy this week, weighing progress on vaccinations and rising consumer prices against weak economic data from the latest round of lockdowns.

Economists are forecasting no changes to the central bank’s government bond-buying program or its forward guidance for interest rate hikes. The bank’s overnight policy rate has been at 0.25 per cent since March, 2020, and it has said it will not raise rates until the second half of 2022 at the earliest.

Wednesday’s regularly scheduled rate decision will be issued a week after Statistics Canada data showed the country’s economic recovery stalling in April and May amid renewed COVID-19 restrictions.

Real GDP fell 0.8 per cent in April – the first drop in a year – according to preliminary estimates, and the country shed 207,100 jobs in April and a further 68,000 jobs in May. Statscan also reported 5.6-per-cent annualized GDP growth in the first quarter, which is below the central bank’s most recent forecast of 7-per-cent growth in the quarter.

“While the outlook remains quite positive, the events of the past year suggest that the [Bank of Canada] will proceed cautiously in pulling back on stimulus,” Benjamin Reitzes, director of Canadian rates and macro strategist with BMO Capital Markets, wrote in a note.

“The combination of a large forecast miss and rising Canadian dollar only reinforce the likelihood that the policy statement will be a balanced mix of optimism and caution,” he wrote.

The bank made several important changes to monetary policy at its last rate decision in April. It trimmed the size of its government bond-buying program, also known as quantitative easing, to $3-billion a week from $4-billion, and changed its forward guidance for a potential interest rate hike to the second half of 2022 from 2023. This put it ahead of other major central banks in unwinding the emergency stimulus introduced at the outset of the pandemic.

“Tiff Macklem and his team might as well take the week off,” CIBC World Markets chief economist Avery Shenfeld wrote in a note, referring to the central bank governor.

“It’s much too early to think about a rate hike. Bank of Canada bond purchases are already being tapered off. Further steps in that direction won’t, therefore, represent a change in direction, and will be done with little fanfare, or market reaction, over the balance of the year. Indeed, decisions on rates and tapering are largely on autopilot for 2021,” he wrote.

There has been a notable uptick in inflation since the last rate decision. The Consumer Price Index rose 3.4 per cent in April, the fastest annual pace of inflation in nearly a decade, while the average of the three core inflation metrics favoured by the bank moved above its 2-per-cent target.

Mr. Macklem has so far played down the spike in inflation, saying it’s a result of temporary factors, notably year-over-year comparisons for gasoline prices. But he did acknowledge last month that supply chain constraints and unexpected pockets of labour market strength could cause inflation to come in above the bank’s forecast.

“If there is a material [change], and we view this as a real step up in our whole inflation forecast, that is something that we would definitely take into consideration in our monetary policy decisions. We certainly have the tools and we have the commitment to achieve our inflation mandate,” he said.

Analysts will be paying close attention to the bank’s comments on the Canadian dollar. The loonie has been the top performing Group of 10 currency so far this year, driven by strong commodity prices and Canada’s relatively aggressive monetary policy.

While high commodity prices are positive for many exporters, there are concerns that the strong dollar will hurt non-commodity exporters. Mr. Macklem noted last month that the strength of the loonie presents a downside risk to the bank’s growth and inflation forecasts. In a note last week, Mr. Shenfeld and CIBC senior economist Royce Mendes said the bank should be more explicit in its warnings.

“Dial down the calming rhetoric that the loonie’s gains are in line with fundamentals, and instead, explicitly remind markets that as a drag on non-resource exports and inflation, the [Canadian dollar’s] gains will push back the timetable for rate hikes in Canada,” they wrote.

Your time is valuable. Have the Top Business Headlines newsletter conveniently delivered to your inbox in the morning or evening. Sign up today.