Wednesday, October 27, 2021

Canada holds rate but ends QE as economy improves

     Canada's central bank left its key interest rate steady, as expected, but surprised financial markets by ending quantitative easing (QE) - one of the monetary tools used to provide extraordinary stimulus during the COVID-19 pandemic - due to progress made in the economic recovery.
     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 cut three times in March 2020 at the height of the pandemic.
      In addition to last year's rate cuts, which totaled 1.50 percentage points, BOC also embarked on asset purchases of government bonds and commercial paper - known as quantitative easing (QE) - to keep longer-term interest rates low and financial markets operating smoothly.
      At first BOC bought C$5 billion of government securities a week and later expanded these purchases to include bonds from Canada's provinces and corporate bonds.
      In October last year BOC shifted its purchases toward longer-term bonds and lowered the weekly amount to $4 billion.
      But in April this year BOC became the first developed market central bank to begin rolling back the extraordinary stimulus provided last year and cut the weekly purchases to $3 billion. In July the weekly purchase amount was lowered further to $2 billion as the economy slowly recovered.
      Today BOC took another major step toward normalizing its monetary policy but said it still views the economy as requiring "considerable monetary policy support" in light of the continued excess capacity in the economy.
     "In light of the progress made in the economic recovery, the Governing Council has decided to end quantitative easing and keep its overall holdings of Government of Canada bonds roughly constant," the bank's monetary policy committee said today.
      As bonds mature at different times, BOC will move to a monthly rather than a weekly target for bond purchases and set the purchase range at $4 billion to $5 billion a month. This includes $1 -$2 billion of bonds in the primary market and about $2.5 billion to $3.5 billion in the secondary market.
      BOC described this shift to maintaining its holdings of bonds rather than expanding them as a "reinvestment phase," and said the length of this phase was part of the monetary policy decisions that are based on the strength of the economy and inflation.
     "But as I indicated in September, it is reasonable to expect that we will be there for a period of time, at least until we raise our policy interest rate," BOC Governor Tiff Macklem said about the bond holdings.
      BOC also reiterated its forward guidance, saying it remains committed to keeping its policy rate at the current level until the economic slack is absorbed so the 2 percent inflation target is achieved.
      The central bank expects this to happen in the middle of next year.
      In an update to its monetary policy report, BOC lowered its forecast for economic growth this year to 5.1 percent from 6.0 percent and the 2022 forecast to 4.3 percent from 4.6 percent. Last year Canada's economy shrank 5.3 percent.
     The forecast for inflation this year was raised to 3.4 percent from 3.0 percent and the 2022 forecast to 3.4 percent form 2.4 percent. In 2020 inflation averaged 0.7 percent.

     The Bank of Canada released the following policy decision followed by a statement by its governor, Tiff Macklem:

"The Bank of Canada today held 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’s extraordinary forward guidance on the path for the overnight rate is being maintained. The Bank is ending quantitative easing (QE) and moving into the reinvestment phase, during which it will purchase Government of Canada bonds solely to replace maturing bonds.

The global economic recovery from the COVID-19 pandemic is progressing. Vaccines are proving highly effective against the virus, although their availability and distribution globally remain uneven and COVID variants pose risks to health and economic activity. In the face of strong global demand for goods, pandemic-related disruptions to production and transportation are constraining growth.  Inflation rates have increased in many countries, boosted by these supply bottlenecks and by higher energy prices. While bond yields have risen in recent weeks, financial conditions remain accommodative and continue to support economic activity.

The Bank projects global GDP will grow by 6½ percent in 2021 – a strong pace but less than projected in the July Monetary Policy Report (MPR) – and by 4¼ percent in 2022 and about 3½ percent in 2023.

In Canada, robust economic growth has resumed, following a pause in the second quarter. Strong employment gains in recent months were concentrated in hard-to-distance sectors and among workers most affected by lockdowns. This has significantly reduced the very uneven impact of the pandemic on workers. As the economy reopens, it is taking time for workers to find the right jobs and for employers to hire people with the right skills. This is contributing to labour shortages in certain sectors, even as slack remains in the overall labour market.

The Bank now forecasts Canada’s economy will grow by 5 percent this year before moderating to 4¼ percent in 2022 and 3¾ percent in 2023. Demand is expected to be supported by strong consumption and business investment, and a rebound in exports as the US economy continues to recover. Housing activity has moderated, but is expected to remain elevated. On the supply side, shortages of manufacturing inputs, transportation bottlenecks, and difficulties in matching jobs to workers are limiting the economy’s productive capacity. Although the impact and persistence of these supply factors are hard to quantify, the output gap is likely to be narrower than the Bank had forecast in July.

The recent increase in CPI inflation was anticipated in July, but the main forces pushing up prices – higher energy prices and pandemic-related supply bottlenecks – now appear to be stronger and more persistent than expected. Core measures of inflation have also risen, but by less than the CPI. The Bank now expects CPI inflation to be elevated into next year, and ease back to around the 2 percent target by late 2022. The Bank is closely watching inflation expectations and labour costs to ensure that the temporary forces pushing up prices do not become embedded in ongoing inflation.  

The Governing Council judges that in view of ongoing excess capacity, the economy continues to require considerable monetary policy support. We remain committed to holding 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 the Bank’s projection, this happens sometime in the middle quarters of 2022. In light of the progress made in the economic recovery, the Governing Council has decided to end quantitative easing and keep its overall holdings of Government of Canada bonds roughly constant.

We will continue to provide the appropriate degree of monetary policy stimulus to support the recovery and achieve the inflation target."

      Opening statement by Governor Tiff Macklem:


Post a Comment