The Bank of Canada kept its overnight target rate at 0.25 per cent while outlining a more confident view on the Canadian economy, as vaccine approvals and increased fiscal stimulus boost the medium-term growth outlook even as current lockdown measures take a significant toll.
In its monetary policy decision on Wednesday, the central bank shrugged off market speculation that it could use a “micro-cut” to stimulate the economy through the second wave of coronavirus infections. It also maintained the pace of its quantitative easing program, saying it would continue buying at least $4-billion worth of Government of Canada bonds every week.
A slight change in language around the QE program, however, led analysts to predict that it could begin tapering its bond purchases in the first half of the year.
After a 5.5-per-cent decline in real GDP in 2020, the bank now expects the Canadian economy to grow by around 4 per cent in 2021 and almost 5 per cent in 2022, before slowing to around 2.5 per cent in 2023. It is projecting global economic growth to average just over 5 per cent in 2021 and 2022.
The approval of several coronavirus vaccines drove the revised growth estimates, and in its quarterly Monetary Policy Report (MPR), published Wednesday, the bank moved its expectations for widespread Canadian immunization ahead by six months, from mid-2022 to the end of 2021.
While the economic outlook is “stronger and more secure” than it was in October, the bank said that things are worse than expected in the near-term owing to surging coronavirus infections and strict lockdowns in several provinces. It is projecting negative 2.5 per cent GDP growth in the first quarter of 2021.
“The earlier expected arrival of vaccines is a very positive development, and we do expect to see stronger growth through the second half of this year and into the first half of next year,” bank governor Tiff Macklem said in a Wednesday press conference.
“But we’re starting off in a deeper hole, so we’ve got to climb back out of that,” he said.
The bank reiterated its pledge to hold its policy rate at the “effective lower bound” – which is currently deemed to be 0.25 per cent – until inflation “sustainably” returns to 2 per cent. It still does not expect inflation to return to that target until some time in 2023.
“This is a less dovish Bank of Canada than some may have thought, because it’s a central bank that has greater confidence in the recovery ahead,” CIBC World Markets chief economist Avery Shenfeld wrote in a note to clients.
“But make no mistake, this is still a dovish policy stance, one that will hold interest rates at rock bottom levels for another two years, and continue to buy bonds this year to keep longer rates from too sharp a climb,” he wrote.
While the bank left much of its language about monetary stimulus unchanged in Wednesday’s policy statement, there was a subtle but important change in how it spoke about its quantitative easing program. The bank is currently buying at least $4-billion worth of Government of Canada bonds a week – in an effort to drive up the price of the benchmark bonds and drive down yields – and now owns roughly 36 per cent of all outstanding federal government bonds.
“As the Governing Council gains confidence in the strength of the recovery, the pace of net purchases of Government of Canada bonds will be adjusted as required,” it said, striking a more optimistic note than before about an economic rebound.
“That suggests that the timing for tapering isn’t that far off,” wrote Benjamin Reitzes, director of Canadian Rates at BMO Capital Markets.
“April is a reasonable timeline for tapering as we should have the FY21/22 federal budget in hand by then, which will give us a profile for issuance that is expected to be materially lower than this year,” he wrote. Other analysts said they expected the bank to begin tapering its purchases by early summer.
At the press conference, Mr. Macklem said that any reduction in bond buying would be “gradual.”
“It’s a process and not a switch. And we’ve committed to continue the QE program until the recovery is well under way. We expect a protracted recovery; this is going to take some time, we’re going to need this program for some time,” he said.
Uncertainty around inflation remains “unusually high,” the bank said in its MPR. A stronger-than-anticipated bounce back in consumer spending, strength of the Canadian dollar against the U.S. dollar, or additional fiscal stimulus could all impact the path of inflation.
And even as the overall economic outlook has improved, the bank continued to warn that growth in the coming quarters will be choppy.
“This is because suppressed spending from containment restrictions in one quarter is likely to be followed by a bounce in another quarter after measures are eased. The choppiness should diminish over time as the share of the immunized population increases and economic momentum becomes more sustained,” the bank wrote in the MPR.
The bank also warned that there are risks to the economic outlook related to the distribution or effectiveness of COVID-19 vaccines. This comes as the federal government says Canada will not receive any shipments of the Pfizer vaccine next week owing to worldwide shipment delays.
The latest round of lockdowns are once again hitting high-contact industries, such as travel and hospitality, particularly hard. At the same time, changing consumption patterns means the economic impact of the second wave of lockdowns will likely be “less severe” than the lockdowns last spring, the bank said. And if restrictions are dialled back in the coming months, “a sharp bounce-back is expected in the second quarter,” the bank said.
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