Bank of Canada holds rate, expecting strong rebound this summer

The central bank reiterated its guidance that rates would remain unchanged until at least the second half of 2022

The Bank of Canada says simple math is making the current economic backdrop look worse than it is in reality, setting up a second taper of its bond-buying program as early as next month.

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Statistics Canada last week reported that gross domestic product (GDP) grew at an annual rate of 5.6 per cent in the first quarter, more than a percentage point slower than the central bank’s forecast. That could have been cause for concern. But rather than emphasize the negative, policy-makers characterized the pace of the recovery in the first quarter as “robust,” suggesting they will continue to gradually reduce the bank’s influence in markets in order to offset inflationary pressures that are building as the economy rebounds from last year’s historic collapse.


“Economic developments have been broadly in line with the outlook,” the central bank said in a new policy statement on June 9. “With vaccinations proceeding at a faster pace, and provincial containment restrictions on an easing path over the summer, the Canadian economy is expected to rebound strongly, led by consumer spending.”

Governor Tiff Macklem and his deputies on the Governing Council said the official tally of GDP came up short of what they were expecting because companies depleted inventories to a greater extent than usual, and because imports were strong. Imports subtract from GDP because money leaves the country to pay for them, but they also imply healthy domestic demand. Low inventories herald future growth, since companies will have to replenish their stores. Bottom line: businesses and households appear to have money to spend.

“The underlying details indicate rising confidence and resilient demand,” the statement said.

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To be sure, the Bank of Canada remains concerned about the present state of the economy, as the hole left by the COVID-19 crisis is as yet unfilled.

Policy-makers ended their fourth of eight scheduled interest-rate reviews this year with a decision to stay in a holding pattern until they get further confirmation that the world is unfolding as they assume it will. They reiterated that they intend to leave the benchmark lending rate at a record low of 0.25 per cent until at least the second half of 2022, and they re-upped their commitment to create about $3 billion per week to purchase Government of Canada bonds.

The Bay Street economists who watch the central bank most closely had assumed the Bank of Canada would leave its policies unchanged. Macklem has said that he is prepared to run the economy hot until hiring returns to pre-pandemic levels, and that he assumes the burst in inflation this spring will be a temporary phenomenon. He could adjust his thinking if facts change, but nothing has happened since the Bank of Canada updated its outlook in April that requires a course correction.

“The recovery continues to require extraordinary monetary policy support,” Macklem and his deputies said, as they have in previous statements when they were less optimistic about the economy’s near-term prospects.

The Bank of Canada’s policy stance is aggressive based on its own history, but it has emerged as perhaps the most prudent of the world’s major central banks, deciding in April to taper its weekly bond purchases to $3 billion from $4 billion, while the U.S. Federal Reserve and others show little sign of easing up on stimulus.
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Some analysts interpreted the Bank of Canada’s confidence in the economy’s momentum as a sign it is getting ready to pare its bond-buying program again when it next updates interest-rate policies in July.

Like the first quarter, policy-makers said what they have seen so far in April, May and June is in line with their prediction for growth of 3.5 per cent in the second quarter.

But the Bank of Nova Scotia’s real-time forecast, which updates whenever new data are released, is currently tracking growth of about one per cent. And Benjamin Reitzes, an economist at Bank of Montreal, said he predicts little or no growth in the current quarter because of the third wave of COVID-19, which, if right, would mean the central bank will miss its forecast by five percentage points over two quarters.

“The willingness of policy-makers to shrug off what could be a big miss on their first-half growth forecast clearly points to a hawkish bias,” Reitzes said in a note to clients. “We had been expecting the next taper to come in October, as we’ll have precious little evidence of the recovery’s strength in July, but today’s statement suggests the bank wants to act sooner rather than later.”

It makes sense for the Bank of Canada to turn a bit “hawkish.” Its primary mission is to keep the Consumer Price Index (CPI) advancing at an annual pace of about two per cent and in April, the CPI surged to 3.4 per cent, breaching the high end of policy-makers’ comfort zone for the first time since the autumn of 2011.
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The Bank of Canada stuck to its view that the recent burst of inflation will pass, maintaining that current year-over-year readings are being exaggerated by the economy’s brush with deflation in 2020. In other words, as with GDP, basic math is making things look worse than they really are.

Still, policy-makers indicated that they are sensitive to the possibility that they could be wrong, going out of their way on June 9 to state that the factors they have previously identified as risks to their inflation outlook “remain relevant.”

Hawkish, indeed.

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