The Bank of Canada has pledged to keep its key interest rate near zero throughout the economy’s recovery from the COVID-19 pandemic, which it said will be protracted and uneven.
In its interest-rate decision on Wednesday, the central bank held its key rate steady at 0.25 per cent, reiterating that it considers this effectively to be the bottom. But it added a promise to keep it there “until economic slack is absorbed” so that inflation can be sustainably maintained at 2 per cent, the target the bank uses to guide its interest-rate policy.
“We recognize that households and businesses are facing an unusual amount of uncertainty,” Bank of Canada Governor Tiff Macklem said in a news conference. “Against that background, we are being unusually clear that interest rates are going to be low for a long time.”
The bank also reaffirmed that it would continue its other major approach to economic stimulus – its minimum weekly purchase of $5-billion worth of government of Canada bonds – “until the recovery is well under way.”
The explicit commitment on rates – a policy strategy known in central banking as “forward guidance” – came as the bank released its first economic forecasts since the COVID-19 crisis began. It estimated that the economy shrank by 15 per cent in the first half of the year, and projected that even with the sharp postlockdown rebound, the economy will decline by 7.8 per cent for 2020 as a whole.
“Our message is that it’s going to be a long climb back, and the Bank of Canada is going to be there through the full length of the recovery, until economic slack is absorbed,” Mr. Macklem said.
People who have a mortgage or are considering a major purchase, or businesses thinking about making an investment can be confident interest rates will be low for a long time, he said. “Low interest rates make spending and investment more affordable, and spending and investment will support the recovery.”
Arlene Kish, director of Canadian economics at research firm IHS Markit, said in a commentary that Mr. Macklem’s forward guidance “points to interest rates remaining unchanged until 2023.”
The news conference followed the publication of the bank’s quarterly Monetary Policy Report (MPR) – Mr. Macklem’s first as head of the bank. He succeeded Stephen Poloz just six weeks ago. The bank usually updates its economic forecasts in each MPR, but Mr. Poloz opted against specific projections in April, citing extreme uncertainty at the height of the crisis.
In the report, the bank estimated that real gross domestic product plunged 13.1 per cent in the second quarter, on top of a 2.1-per-cent contraction in the first quarter. It expects a bounce-back of 7.1 per cent in the third quarter, reflecting the rapid return of activity as more containment restrictions are lifted. The forecast assumes that “about 40 per cent” of the drop in output in the first half of the year will be recouped in the third quarter.
However, it cautioned that it expects this initial rebound to be followed “by a more prolonged recuperation phase, which will be uneven across regions and sectors.” It forecast that the economy would grow by 5.1 per cent in 2021 and 3.7 per cent in 2022 as the impact of the crisis dissipates – but it doesn’t see economic output returning to prepandemic levels until well into 2022.
The bank called its new outlook a “central scenario,” rather than a projection, emphasizing the continued uncertainty surrounding the numbers. The central scenario assumes no widespread second wave of COVID-19 in Canada or globally, and that the pandemic will have run its course by mid-2022.
“There are a multitude of scenarios both stronger and weaker than the central one presented here,” the bank said. Yet it cautioned that, over all, the bigger risks in the alternative scenarios appear to be an even weaker recovery, largely because of the potential for a second wave of the virus.
It estimated that the inflation rate – a key measure for the bank – fell to -0.1 per cent in the second quarter. The bank forecast that even as the economy reopens, inflation would be a thin 0.4 per cent in the third quarter, and just 0.6 per cent for the year as a whole, before picking up modestly to 1.2 per cent in 2021 and 1.7 per cent in 2022.
“The dramatic decline in [energy] prices in March and April will hold inflation down until early 2021. After that, the inflation outlook depends primarily on the speed and strength at which demand and supply recover,” the bank said. “Firms report that capacity could return quickly as the economy reopens and containment measures are lifted. They expect the recovery in demand to be more muted, especially in the services and energy sectors.”
In his short time on the job, Mr. Macklem has generally struck a more cautious tone than his predecessor Mr. Poloz, who was relatively optimistic about the potential for the economy to recover. Wednesday’s rate-decision statement, Monetary Policy Report and news conference reflected that subtle shift under the new leader, although the bank broadly remained consistent with the crisis-fighting policy stand Mr. Poloz put in place in his final months in office, which included deep rate cuts and the introduction of large-scale bond purchases.
But Charles St-Arnaud, chief economist at Alberta Central, the province’s credit-union association, said Mr. Macklem’s call for Canadians to rely on a long period of low rates to finance consumption seemed at odds with the bank’s long-standing concerns about elevated consumer debt.
“I find it interesting that missing from that statement is the risk of pushing already extremely leveraged households and businesses to even more extreme levels,” he said. “It feels a bit like the BoC is somewhat contradicting itself.”
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