The Bank of Canada left monetary policy unchanged on Wednesday in a rate announcement that highlighted supply chain disruptions while painting a mixed picture of the economy in the wake of unexpectedly weak growth data.
The central bank said it expects the economy to strengthen in the second half of the year, although it warned that another wave of COVID-19 cases and continuing supply bottlenecks “could weigh on the recovery.”
With the rate decision landing in the middle of a federal election campaign, the bar for change was high. The bank opted to keep its benchmark interest rate at 0.25 per cent, where it has been since early in the pandemic, and maintain its current pace of government bond buying at $2-billion a week.
“The Bank of Canada kept a low profile at this meeting, with the policy statement making few, if any, waves. That’s exactly what was expected as federal election day is less than two weeks away,” Benjamin Reitzes, Canadian rates and macro strategist with Bank of Montreal, wrote in a note to clients.
The rate decision comes a week after Statistics Canada reported weaker-than-expected growth in the spring and early summer. Canadian real GDP fell 1.1 per cent on an annualized basis in the second quarter, about three percentage points below the central bank’s forecast. Preliminary Statscan data show the economy shrank a further 0.4 per cent in July on an annualized basis.
The bank offered a relatively optimistic interpretation of the data. It said the GDP miss was largely attributable to supply chain problems, particularly in the auto sector, where difficulty sourcing microchips has forced car makers to slow production and cut into vehicle exports. It also noted the slowdown in housing market activity after frenzied buying earlier in the year.
At the same time, the bank highlighted the fact that household consumption, business investment and government spending in the second quarter “all contributed positively to growth, with domestic demand growing at more than 3 per cent.” And it noted that employment bounced back in June and July, as public-health restrictions eased.
“We thought the bank would emphasize downside risks to its July projections but today’s policy statement provided a more balanced assessment of economic conditions than we anticipated,” Royal Bank of Canada senior economist Josh Nye wrote in a note to clients.
The bank continued to play down inflation worries on Wednesday. The annual rate of consumer price index growth has been above the bank’s target range since May, hitting a decade-high 3.7 per cent in July.
The bank reiterated the view that the recent runup in inflation is largely the result of temporary factors, such as supply chain bottlenecks and year-over-year comparisons to lower prices earlier in the pandemic.
“These factors pushing up inflation are expected to be transitory, but their persistence and magnitude are uncertain and will be monitored closely. Wage increases have been moderate to date, and medium-term inflation expectations remain well-anchored,” the bank said in its statement.
The combination of high inflation and weaker-than-expected growth puts the bank in an awkward position. Toronto-Dominion Bank senior economist Sri Thanabalasingam said the bank will have to be nimble in the coming months and responsive to new data.
“A solid gain in jobs in August alongside a tempering of price pressures should leave the bank on track to gradually reduce monetary stimulus in coming quarters. However, if the [August] employment report disappoints or inflation picks up further, the bank’s governing council will face a more difficult tradeoff,” Mr. Thanabalasingam wrote in a note to clients.
“Boosting monetary stimulus could further aid the recovery, especially given the Delta variant risk, but runs the risk of accelerating price growth,” he wrote.
Most analysts expect the bank to further taper its pace of federal government bond buying, known as quantitative easing, at the next rate decision on Oct. 27. At that point, the bank will have updated economic forecasts in its quarterly Monetary Policy Report.
The bank is still ahead of most other major central banks in reducing emergency stimulus. It has reduced its pace of government bond buying three times over the past year, to $2-billion a week from $5-billion a week at the outset of the pandemic.
Bank of Canada Governor Tiff Macklem will give more details about the bank’s thinking on Thursday in a speech to the Quebec chambers of commerce titled “QE and the reinvestment phase.”
Any decision to raise interest rates is likely a long way off. Mr. Macklem has promised to hold the bank’s policy rate at 0.25 per cent until slack in the economy is absorbed.
“In the bank’s July projection, this happens in the second half of 2022,” the bank said Wednesday.
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Mark Rendell