Balancing a stronger-than-expected economic rebound with a second wave of the COVID-19 pandemic, the Bank of Canada looks unlikely to make any dramatic moves in this week’s monetary policy decision. But the financial markets will nevertheless be looking for hints on where the central bank will take its highly stimulative policy position from here.
On Wednesday, the bank will release its regularly scheduled interest rate decision, along with its first quarterly economic projections since mid-July. The rate itself will not be the news. The bank has repeatedly referred to the current policy rate of 0.25 per cent as “the effective lower bound,” or bottom. At the same time, the bank has pledged to keeping rates at the lower bound “until economic slack is absorbed so that the [bank’s] 2-per-cent inflation target is sustainably achieved” – something that economists believe is unlikely before 2023. The rate looks bolted in place.
However, central bank watchers will be looking to the rate announcement and quarterly Monetary Policy Report for a clearer picture of how rookie governor Tiff Macklem and his colleagues view the competing economic forces that have come into play since its July analysis – and any hints about what that might mean for monetary policy as the pandemic and the fragile recovery continue, even if it means a largely stand-pat position for now.
“The Bank of Canada’s upcoming rate decision, and its Monetary Policy Report, will be crafted to meet the Hippocratic oath: First, do not harm,” Canadian Imperial Bank of Commerce chief economist Avery Shenfeld and strategists Ian Pollick and Bipan Rai wrote in a research report. “Its intent will be to restrict itself to some fine-tuning, and avoid any major shifts in a monetary policy stance that is working well, in an economy that isn’t.”
Without doubt, the economy’s postlockdown rebound has been much faster and stronger than the Bank of Canada had anticipated in its July outlook. After the economy contracted at a massive 38.7-per-cent annualized rate in the second quarter, economists estimate that it rebounded by about 46 per cent annualized in the third quarter, much better than the 31 per cent that the central bank predicted in July.
As a result, economists now expect real gross domestic product for the full year to be down about 5.7 per cent – still a severe slowdown, but not as bleak at the Bank of Canada’s July forecast of minus 7.8 per cent. Observers expect the central bank to upgrade its 2020 GDP projections considerably in its updated outlook.
Still, inflation is barely registering – just 0.5 per cent in September – a sign that the economy is running far below its full speed. And now the bank faces the relatively new threat of the coronavirus’s second wave – which will affect not only its economic outlook for the rest of the year and into 2021, but also its policy options beyond its interest rate.
“Given the risk that harsher restrictions could eventually be imposed, there seems little chance of the bank altering its very cautious tone,” Capital Economics senior Canada economist Stephen Brown said in a research report last Friday. “We expect it to repeat the message that rates will be kept very low for years, and give some guidance as to how it might react if the downside risks to the outlook materialize.”
Markets will be looking for some additional clarity on the future of the Bank of Canada’s quantitative easing, or QE, program, which looks to be its most immediate tool to adjust its stimulus as long as its key rate remains essentially frozen. Since the beginning of April, the bank has been buying a minimum $5-billion a week of Government of Canada bonds in the open market – initially to help stabilize badly wobbling financial markets, but increasingly as a way to dampen market interest rates and stimulate lending as the markets have found stronger footing.
In the Bank of Canada’s most recent rate decision, in early September, it talked about “calibrating” its QE program to provide the appropriate stimulus. Most observers took this to imply that the bank was preparing to fine-tune the program to target interest rates at specific maturities (a strategy known as yield curve control), possibly as a precursor to eventually reducing the size of its purchases.
Indeed, with the central bank now holding about 30 per cent of the entire government bond market as a result of seven months of large-scale buying, there have been growing rumblings for the bank to at least provide some visibility into when it might step back, and at least slow the growth of its increasingly large footprint.
“The obvious question that follows is: When should the BoC taper [its purchases]? To us, an announcement at [Wednesday’s] monetary policy meeting wouldn’t come as a huge surprise,” National Bank of Canada economist Jocelyn Paquet said in a report.
But the uncertainty stemming from COVID-19’s second wave could put any substantial changes on hold.
“The optics around pulling back stimulus just as newly announced provincial lockdowns take effect – alongside rising case loads – would be interpreted as being a bit odd, to put it mildly,” the CIBC report said. “Rather, we expect some operational adjustments to the [program] that would help produce more stimulus into the system, while allaying concerns about the bank’s heavy hand in the market.”
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