The Bank of Canada took another step in unwinding its emergency stimulus and raised its forecast for inflation Wednesday, noting the economy is primed for rapid growth in the second half of the year, led by a surge in consumer spending.
The central bank cut its government bond purchases to a target of $2-billion a week, from $3-billion, further reducing the stimulus put in place early in the COVID-19 pandemic. It held its policy rate at 0.25 per cent and reaffirmed it does not expect to raise interest rates before the second half of 2022 at the earliest.
The rate decision comes at a turning point for the Canadian economy. Businesses are reopening and hiring workers after months of health restrictions. Consumer confidence is back to prepandemic levels, and the bank now expects people to spend a significant portion of their extra savings over the coming quarters.
“With cases falling, rapid progress on vaccinations and easing containment measures, the governing council is increasingly confident that growth will rebound strongly as the economy once again reopens, and this time growth will be more durable,” Bank Governor Tiff Macklem said in a news conference.
The bank’s decision to taper its federal government bond-buying program for the second time this year moves it further ahead of other central banks in tightening monetary policy. Central bankers around the world face the delicate task of supporting the economic recovery with low interest rates and large-scale asset purchases, while keeping an eye on inflation, which has surged in recent months.
The bank raised its own inflation expectations on Wednesday. It now expects consumer price index (CPI) inflation to remain above 3 per cent for the rest of the year before dropping down close to 2 per cent next year. Inflation is then projected to rise moderately in 2023, before settling sustainably back to the bank’s 2-per-cent target in 2024.
In recent months, consumer price growth has been significantly hotter than the bank projected, with the CPI growing at an annual rate of 3.6 per cent in May and 3.4 per cent in April. On Tuesday, the United States reported 5.4-per-cent inflation in June, the highest year-over-year price growth in 13 years.
Mr. Macklem said factors driving the current spike in inflation are transitory: supply-chain bottlenecks, rising gasoline prices and year-over-year comparisons of prices of goods and services that fell early in the pandemic. But he acknowledged inflation is expected to remain above target for several years as a result of the bank’s decision to keep interest rates low for an extended period.
“Because we’re holding the policy rate at the effective lower bound until [the output gap] closes, and there are some lags in monetary policy, you can expect to see some modest excess demand in 2023 … so that produces a modest increase in inflation above the target before we go back towards target in 2024,” Mr. Macklem said.
The bank’s quarterly Monetary Policy Report, published Wednesday, showed a brightening economic outlook after a challenging quarter. The bank lowered its 2021 GDP growth forecast by half a percentage point because of recent lockdown measures during Canada’s third wave of COVID-19 infections. At the same time, it raised its growth outlook for 2022 to 4.6 per cent from 3.7 per cent.
The bank expects consumer spending on things such as accommodation, transportation and restaurants to drive growth through the summer and into the fall. It’s also counting on improving commodity prices and a red hot U.S. economy to improve exports.
A recent bank survey found consumers eager to spend the money they saved during the pandemic, and the bank now expects people to spend around 20 per cent of their additional savings in the coming years. That will provide a major boost to aggregate economic demand.
Much of the bank’s outlook remains contingent on a broad-based labour market recovery. In his news conference, Mr. Macklem highlighted the recent Statistics Canada employment report, showing the economy added 230,700 jobs in June. But he cautioned the economy still needs to recover 550,000 jobs to return to prepandemic employment levels, and said the bank will monitor a wide range of labour market metrics to gauge the strength of the rebound.
“After a surprisingly hawkish fusillade in April, today’s set of announcements was much less market moving, with the Bank offsetting its mostly sunny outlook with some notes of caution and/or uncertainty,” Bank of Montreal chief economist Douglas Porter wrote in a note.
The central bank’s reduction in weekly bond purchases, also known as Quantitative Easing (QE), was widely expected by economists, and bond market reaction to the news was subdued. The bank is buying federal government bonds as a form of monetary policy stimulus, aimed at keeping benchmark interest rates down to encourage borrowing.
Mr. Macklem said QE is still necessary, but reiterated that less of it will be needed over time if the economy evolves in line with the bank’s projections.
“We expect the tapering process to continue apace, with the Bank winding down its QE by early next year. This will set the stage for rate hikes, likely within the next 12 months of the end of QE, with a good chance of sooner rather than later,” Mr. Porter wrote.
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