Wednesday, October 28, 2020

Canada holds rate, trims QE and to focus on long bonds

     Canada's central bank left its benchmark interest rate steady but will reduce its purchases of bonds and focus on buying more longer-term bonds so the net effect is there is no reduction in the level of monetary stimulus, which it confirmed will continue until the economic recovery is well underway.
     The Bank of Canada (BOC) left its target for the overnight rate at the effective lower bound of 0.25 percent, unchanged since it was slashed three times in March by a total of 150 basis points to what it considers the "effective lower bound."
      Along with the rate cuts, BOC in March also began buying C$5 billion of government securities a week in the secondary market across a wide range of maturities.
      Today the bank's council said it would gradually reduce these purchases to $4 billion a week and recalibrate its quantitative easing (QE) program toward longer-term bonds that have a more direct influence on the borrowing rates that a most important for households and businesses.
     "The Governing Council judges that, with these combined adjustments, the QE program is providing at least as much monetary stimulus as before," BOC said, reiterating its guidance that it will keep the policy rate at the effective lower bound until the 2.0 percent inflation target is reached.
     The decision comes against a backdrop of an upward revision of the bank's growth forecast for this year to a contraction of 5.7 percent compared with an earlier forecast of a 7.8 percent decline due to a stronger-than-expected rebound in the summer.
      But growth in the fourth quarter is expected to slow markedly due to rising COVID-19 cases as the economy's transition to what BOC said was a "more moderate recuperation phase," with growth continuing to rely heavily on policy support.
     BOC lowered its 2021 growth forecast to 4.2 percent from 5.1 percent but maintained the 2022 forecast for growth of 3.7 percent. But in light of the long-lasting effects of the pandemic, the estimate for Canada's potential growth rate was revised down.
     Canada's inflation rate rose to 0.5 percent in September from 0.1 percent in the previous two months but is expected to remain below the bank's target range of 1.0 to 3.0 percent until early 2021, mainly due to lower energy prices.
      BOC forecast headline inflation of an unchanged 0.6 percent this year, 1.0 percent in 2021 and 1.7 percent in 2022, below 2019's 1.9 percent.

     The Bank of Canada issued the following statement and an opening statement by its governor, Tiff Macklem:


"The Bank of Canada today maintained its target for the overnight rate at the effective lower bound of ¼ percent, with the Bank Rate at ½ percent and the deposit rate at ¼ percent. The Bank is maintaining its extraordinary forward guidance, reinforced and supplemented by its quantitative easing (QE) program. The Bank is recalibrating the QE program to shift purchases towards longer-term bonds, which have more direct influence on the borrowing rates that are most important for households and businesses. At the same time, total purchases will be gradually reduced to at least $4 billion a week. The Governing Council judges that, with these combined adjustments, the QE program is providing at least as much monetary stimulus as before.

The global and Canadian economic outlooks have evolved largely as anticipated in the July Monetary Policy Report(MPR), with rapid expansions as economies reopened giving way to slower growth, despite considerable remaining excess capacity. Looking ahead, rising COVID-19 infections are likely to weigh on the economic outlook in many countries, and growth will continue to rely heavily on policy support.

In the United States, GDP growth rebounded strongly but appears to be slowing considerably. China’s economic output is back to pre-pandemic levels and its recovery continues to broaden. Emerging-market economies have been hit harder, especially those with severe outbreaks. The recovery in Europe is slowing amid mounting lockdowns. Overall, global GDP is projected to contract by about 4 percent in 2020 before growing by just over 4 ½ percent, on average, in 2021–22.

Oil prices remain about 30 percent below pre-pandemic levels. Meanwhile, non-energy commodity prices, on average, have more than fully recovered. Despite continued low oil prices, the Canadian dollar has appreciated since July, largely reflecting a broad-based depreciation of the US dollar. 

In Canada, the rebound in employment and GDP was stronger than expected as the economy reopened through the summer. The economy is now transitioning to a more moderate recuperation phase. In the fourth quarter, growth is expected to slow markedly, due in part to rising COVID-19 case numbers. The economic effects of the pandemic are highly uneven across sectors and are particularly affecting low-income workers. Recognizing these challenges, governments have extended and modified business and income support programs.

After a decline of about 5 ½ percent in 2020, the Bank expects Canada’s economy to grow by almost 4 percent on average in 2021 and 2022. Growth will likely be choppy as domestic demand is influenced by the evolution of the virus and its impact on consumer and business confidence. Considering the likely long-lasting effects of the pandemic, the Bank has revised down its estimate of Canada’s potential growth over the projection horizon.

CPI inflation was at 0.5 percent in September and is expected to stay below the Bank’s target band of 1 to 3 percent until early 2021, largely due to low energy prices. Measures of core inflation are all below 2 percent, consistent with an economy where demand has fallen by more than supply. Inflation is expected to remain below target throughout the projection horizon.

As the economy recuperates, it will continue to require extraordinary monetary policy support. The Governing Council will hold the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved. In our current projection, this does not happen until into 2023. The Bank is continuing its QE program and recalibrating it as described above. The program will continue until the recovery is well underway. We are committed to providing the monetary policy stimulus needed to support the recovery and achieve the inflation objective."

    Opening statement by Governor Tiff Macklem:

"Good morning. Thank you for joining Senior Deputy Governor Wilkins and me to discuss today’s policy announcement and Monetary Policy Report (MPR).

Our main message today is that it will take quite some time for the economy to fully recover from the COVID-19 pandemic, and the Bank of Canada will keep providing monetary stimulus to support the economy through the recovery. 

Before turning to your questions, let me say a few words about our policy discussions.

Obviously, the Governing Council spent a lot of time discussing the current status of the pandemic and its impact on our economy. Simply put, things really depend on how the pandemic evolves. We are basing our outlook on some particular assumptions about the virus.

We assume authorities won’t need to reinstate the sort of extensive and widespread containment measures we saw in the spring. But we can expect successive waves of the virus to require localized and targeted restrictions. The need for these restrictions will ebb and flow, and gradually diminish over time. We are assuming that vaccines and effective treatments will be widely available by the middle of 2022. Finally, we expect that the fallout from the pandemic will have some long-lasting effects on future economic growth.

Since the spring, we have developed a better understanding of the economic effects of containment measures and the impact of the government support programs. With this, and the recognition that the virus is going to be with us for some time, the Governing Council decided to go back to our normal practice of giving a projection for growth and inflation in the MPR. That said, let me stress that the projection is highly conditional on our assumptions about the virus. 

As expected, the Canadian economy bounced back in the third quarter as many businesses reopened. In fact, the rebound was a little stronger than we had anticipated at the time of the July MPR, but we are still over 700,000 jobs below our pre-pandemic level of employment. To put that in perspective, peak job losses in the Great Recession a little more than a decade ago were about 425,000.

The current job losses are concentrated in service sectors, particularly in lower-wage jobs where physical distancing is difficult. This is why the income support programs put in place have been so important for the recovery. They have protected the most vulnerable and supported household spending, which has helped to underpin the recovery in consumption. Housing activity also rebounded sharply in the third quarter as sales made up ground that was lost in the containment phase.

But outside of household and government spending, the economy has struggled. Investment and exports have increased but are still weighed down by uncertainty and weak demand. Meanwhile, the Canadian dollar has been a bit stronger than we assumed in July, despite continued low oil prices.

The Governing Council agreed the very rapid growth of the reopening phase is now over and we are in the slower-growth recuperation phase. We expect fourth-quarter growth to be just barely positive—weaker than previously expected due to the resurgence in COVID-19 infections. For 2020 as a whole, we expect that the economy will have shrunk by about 5 1/2 percent.

Looking out to 2021 and 2022, we are projecting annual growth to average almost 4 percent, with household spending leading the way. But we expect this growth to be uneven across sectors and choppy over time. Some parts of the economy will simply be unable to completely reopen until a vaccine is widely available, so sectors will recover at very different speeds. Moreover, as infection rates fluctuate, economic activity will continue to be affected by containment measures as well as consumer and business caution. We expect business investment to remain weak as uncertainty persists and exports to grow only slowly. When we add it up, the Governing Council projects that the economy will still be operating below its potential into 2023.

Let’s now turn to inflation—our mandated goal. The most recent CPI inflation data came in at 0.5 percent, and it’s expected to stay below our 1 to 3 percent target range until early next year. After that, it is projected to rise gradually, but stay below 2 percent throughout the projection horizon.

The Governing Council also spent a fair bit of time discussing longer-term issues. We know the pandemic is reducing investment and is likely to cause long-lasting damage to some people’s job prospects. These forces will reduce Canada’s economic potential. We have substantially marked down our estimate for Canada’s potential growth to about 1 percent a year through 2023.

I explained earlier how our outlook is highly conditional on assumptions about the virus. Beyond these, it is also subject to several important risks. For example, it’s possible that consumption could be stronger than expected if households quickly reverse the buildup in savings they have accumulated since the start of the pandemic. In contrast, an economic setback could lead to a sharp tightening of financial conditions, further slowing both growth and inflation.

The Governing Council sees the risks around the projection to be roughly balanced. But it’s important to remember that we are operating at the effective lower bound for our policy interest rate and inflation is well below target. So, we are particularly focused on the downside risks to our projection.

Given the outlook, the Governing Council agreed that extraordinary monetary policy support will continue to be needed. Accordingly, we will continue to hold the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved. In our current projection, this takes us into 2023.

We are providing exceptional forward guidance combined with a full economic projection to provide as much clarity as we can to Canadians in an environment of considerable uncertainty.

Our forward guidance is being reinforced and supplemented by our quantitative easing (QE) program. We are recalibrating our program of government bond purchases, and I want to take a moment to explain what we are doing and why.

At the outset of the pandemic, our bond purchases were focused on restoring orderly market conditions, and we concentrated on buying bonds with shorter maturities where issuance was strongest. Now that markets are functioning well and the yields on shorter maturity bonds are well anchored by our forward guidance, we can concentrate more of our bond purchases at longer maturities. Shifting our purchases to longer-maturity bonds increases the amount of monetary stimulus provided per dollar purchased. That’s because it focuses more directly on the borrowing rates that are most relevant for households and businesses.

Given the expected impact from buying more longer-term bonds, the Governing Council judges that, as we gradually reduce our total weekly bond purchases from at least $5 billion to a minimum of $4 billion, our QE program will continue to provide at least as much stimulus as before. This recalibration of the program will increase its effectiveness.

The QE program will continue until the recovery is well underway. We are committed to providing the monetary policy stimulus needed to support the recovery and achieve the inflation objective.

With that, Senior Deputy Governor Wilkins and I will now be happy to take your questions."


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