The Bank of Canada leaves its target overnight benchmark rate unchanged at 0.25%

The biggest news coming from today’s announcement is the Bank updated its thinking on the timing of future interest rate policy movements. For much of the past year, it signaled that policy interest rates would stay at the Bank’s effective “lower bound” until its inflation targets were met – which it did not expect to happen until 2023. It now expects this to occur “sometime in the second half of 2022.” (See “Looking Forward”)

Prior to the announcement, speculation amped up that the Bank would taper asset purchases that have been the central feature of monetary policy since the pandemic began last year. This speculation was correct. The Bank announced that effective April 28, 2021 “weekly net purchases of Government of Canada bonds will be adjusted to a target of $3 billion” reflecting “the progress made in the economic recovery.” Previously, the Bank’s quantitative easing (QE) program involved the weekly purchase of “at least $4 billion” of bonds.

The Monetary Policy Report noted in particular that the overall Canadian outlook has been revised upward since January. The Bank also commented specifically on Canadian housing construction. Here is a summary:

Canadian economic conditions

• The Bank now forecasts real GDP growth of 6.50% in 2021, moderating to around 3.75% in 2022 and 3.25% in 2023
• Growth in the first quarter of 2021 appears to have been “considerably stronger than the Bank’s January forecast,” as households and companies adapted to the second wave and associated restrictions
• Substantial job gains in February and March boosted employment, however new lockdowns will pose another setback “and the labour market remains difficult for many Canadians, especially low-wage workers, young people and women”
• As vaccines roll out and the economy reopens, “consumption is expected to rebound strongly in the second half of this year and remain robust over the projection period”
• Strong growth in foreign demand and higher commodity prices are expected to drive a robust recovery in exports and business investment Canadian Housing
• Housing construction and resales “are at historic highs, driven by the desire for more living space, low mortgage rates, and limited supply”
• The Bank will “continue to monitor the potential risks associated with the rapid rise in house prices”

Global conditions

• Global economic growth is “stronger than was forecast” in the Bank’s January 2021 Monetary Policy Report “although the pace varies considerably across countries”
• After a contraction of 2.5%, the Bank now projects global GDP to grow by just over 6.75% in 2021, about 4% in 2022, and almost 3.50% in 2023
• The recovery in the United States “has been particularly strong, owing to fiscal stimulus and rapid vaccine rollouts”
• The global recovery has lifted commodity prices, including oil, contributing to the strength of the Canadian dollar

Inflation

Over the next few months, the Bank believes inflation will rise temporarily to around the top of its 1-3% “inflation-control range.” However, it attributes this to the fact that prices of some goods and services fell sharply last year and since December, gasoline prices have risen above their pre-pandemic levels.

The Bank therefore expects CPI inflation to “ease back toward 2% over the second half of 2021” as these base-year (2020) effects diminish. Inflation is also expected to ease further because of what the Bank calls the ongoing drag of excess capacity. As slack is absorbed, inflation should return to 2% on a sustained basis “some time in the second half of 2022.”

Looking forward

Even as economic prospects improve, the Bank’s Governing Council believes there is still considerable excess capacity in Canada, and that the economic recovery “continues to require extraordinary monetary policy support.”

Accordingly, it reaffirmed its commitment to holding the policy interest rate at the effective lower bound until economic slack is absorbed so that its 2% inflation target is sustainably achieved. Based on the Bank’s latest projection, this is now expected to happen “some time” in the second half of 2022.

In the meantime, the Bank says it will continue its QE program to keep interest rates low across the yield curve.

The bottom line

Although the Bank’s Monetary Policy Report admits that achieving full recovery will take time, and the impacts of the pandemic remain uneven, its assessment of the strength and durability of the recovery has changed for the better and will continue to evolve this spring depending on the course of COVID-19.