The Bank of Canada held fast on its ultralow interest rate and pace of government-bond buying on Wednesday, while acknowledging that the economy weathered the second wave of the pandemic better than expected and is beginning to gather steam.
The central bank kept its policy interest rate at 0.25 per cent, and reiterated that it does not expect to start raising rates until 2023. It also said that it would continue buying $4-billion worth of government of Canada bonds each week, giving few hints as to when it might begin to “taper” its quantitative easing program.
The key question heading into Wednesday was how the bank would navigate growing optimism in the wake of better-than-expected economic data in both Canada and the United States. Long-term government bond yields have spiked in recent weeks, with the market pricing in faster economic growth, higher inflation and rate hikes as early as next year.
The bank acknowledged the changing outlook while maintaining a somewhat cautious tone because of continuing weakness in the labour market. Analysts suggested that the bank opted for a “do no harm” approach, postponing any meaningful revisions to its outlook and policy position until April 21, when it will publish a new economic forecast alongside its next rate decision.
“The economy is proving to be more resilient than anticipated to the second wave of the virus and the associated containment measures,” the bank said in Wednesday’s one-page statement. It noted that GDP growth in the fourth quarter of 2020 was 9.6 per cent on an annualized basis, twice what the bank had forecast in January, and that GDP is now expected to grow in the first quarter of 2021 rather than contract.
“Consumers and businesses are adapting to containment measures, and housing market activity has been much stronger than expected. Improving foreign demand and higher commodity prices have also brightened the prospects for exports and business investment,” it said.
At the same time, it noted that there is still considerable slack in the economy and uncertainty about the evolution of COVID-19. It said the labour market is “a long way from recovery,” noting that employment is still well below prepandemic levels, and that low-wage workers, young people and women have been hit the hardest.
“This [rate decision] is a placeholder between forecast revisions, and the next one is going to be quite material,” said Derek Holt, head of capital markets economics at the Bank of Nova Scotia, pointing to the April 21 rate decision.
“They have to pretty sharply raise and front load their growth forecasts, probably pull forward the output gap,” he said in an interview.
The solid economic data, combined with another round of fiscal stimulus in the U.S., has already begun fuelling expectations about inflation. In a speech on Tuesday, Royal Bank of Canada chief executive Dave McKay spoke of prices for inputs such as labour and commodities rising “earlier than later.”
“We do see a challenge to the policy and therefore, central banks having to respond to this in 2022, the latter half of 2022, with rate increases. Versus where you might have thought – late 2023, even 2024 – six months ago,” Mr. McKay said.
For its part, the bank said the year-over-year rate of inflation will likely tick up in the coming months, as current prices for goods and services – most notably the price of oil – are compared with prices depressed at the outset of the pandemic. Although it reiterated its view that inflation will moderate in the second half of the year, as “excess capacity continues to exert downward pressure.” It noted that measures of core inflation currently range from 1.3 per cent to 2 per cent.
Economists were watching the rate decision for indications about when the bank might begin slowing its pace of government bond buying, which is being done to keep long-term interest rates down. The bank said nothing new on this front, repeating its January comment that the pace of bond buying will be adjusted as the bank’s governing council gains confidence in the strength of the recovery.
Scotiabank’s Mr. Holt said the bank missed an opportunity on Wednesday to announce changes to the quantitative easing program.
“The market was giving them a free pass, it had already adjusted to some tapering assumptions, so they could have snuck one in. And in this kind of an environment, you take every such opportunity that you can get, when the conditions are right for doing so,” he said.
Analysts remain split as to whether the bank is most likely to begin slowing its pace of bond buying in April or later in June. The bank said on Wednesday that it “will continue its QE program until the recovery is well underway.”
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