Canada maintains rate but says rates need to rise

      Canada's central bank left its key interest rates steady but took another major step forward toward normalizing its monetary policy and raising interest rates rate by dropping its previous guidance that the economy still needs considerable monetary policy support and policy rates would be kept unchanged.

     The Bank of Canada (BOC) left its benchmark 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 COVID-19 pandemic.
     BOC also left its bank rate at 0.50 percent and the deposit rate at 0.25 percent.
     "With overall economic slack now absorbed, the Bank has removed its exceptional forward guidance on its policy interest rate," BOC said, paving the way for interest rate hikes as soon as its next meeting in March.

     At the press conference, BOC Governor Tiff Macklem added the emergency monetary measures that helped support the economy during the pandemic were no longer needed and interest rates will need to rise to control inflation.

    "Second, we want to clearly signal that we expect interest rates will need to increase," Macklem said, adding inflation will come down as the pandemic fades and conditions normalize.

     BOC said it was still in a phase of reinvesting in government bonds by keeping its overall holdings roughly constant, at least until it begins to raise the policy interest rate.

      At that point BOC - which in April last year began reducing its weekly bond purchases and then ended them in October - said it will consider "reducing the size of its balance sheet by allowing roll-off of maturing Government of Canada bonds."
      In recent years central banks have adopted forward guidance as a monetary tool to affect expectations and prices in financial markets, and BOC at its last policy meeting in December reiterated the economy still required considerable support and interest rates would be held at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is achieved.

     Since then it has become clear Canada's economy performed better than expected in the second half of last year and inflation is now at highs not seen for 30 years.

     "While COVID-19 continues to affect economic activity unevenly across sectors, the Governing Council judges that overall slack in the economy is absorbed, thus satisfying the conditions outlined in the Bank's forward guidance on its policy interest rate," BOC said, adding:

     "The Governing Council therefore decided to end its extraordinary commitment to hold its policy rate at the effective lower bound."

     The timing and pace of future rate increases will now be guided by the bank's commitment to achieving the 2.0 percent inflation target, within a range of 1-3 percent.

     BOC's step-by-step tightening of its monetary policy stance since April last year takes place against a backdrop of estimated growth of 4.5 percent in 2021 and the economy entered 2022 with considerable momentum, such as strong employment growth and a tightening labour market, that shows economic slack is absorbed.

     Although the Omicron variant of COVID-19 is weighing on economic activity, BOC said its impact is expected to be less severe and economic growth is expected to bounce back and remain robust, helped by consumer spending on services, exports and investment.

     BOC forecast economic growth in 2022 of 4.0 percent in its latest monetary policy report, down from 4.3 percent previously forecast, and about 3.5 percent in 2023, down from an earlier 3.7 percent.

     Inflation has remained above the upper limit of BOC's target range since April last year and rose to 4.8 percent in December, the highest since September 1991, and BOC expects inflation to remain close to 5 percent in the first half of this year due to persistent supply constraints and higher food and energy prices.

     But as these supply shortages ease, inflation is expected to decline to about 3 percent by the end of this year and gradually ease toward the target.

    "The Bank will use its monetary policy tools to ensure that higher near-term inflation expectations do not become embedded in ongoing inflation," BOC said.

     BOC raised its forecast for 2022 headline inflation to 4.2 percent from an earlier 3.4 percent while the 2023 forecast was unchanged at 2.3 percent.

  

    The Bank of Canada released the following statement:

"The Bank of Canada today held its target for the overnight rate at the effective lower bound of ¼ %, with the Bank Rate at ½ % and the deposit rate at ¼ %. With overall economic slack now absorbed, the Bank has removed its exceptional forward guidance on its policy interest rate. The Bank is continuing its reinvestment phase, keeping its overall holdings of Government of Canada bonds roughly constant.

The global recovery from the COVID-19 pandemic is strong but uneven. The US economy is growing robustly while growth in some other regions appears more moderate, especially in China due to current weakness in its property sector. Strong global demand for goods combined with supply bottlenecks that hinder production and transportation are pushing up inflation in most regions. As well, oil prices have rebounded to well above pre-pandemic levels following a decline at the onset of the Omicron variant of COVID-19. Financial conditions remain broadly accommodative but have tightened with growing expectations that monetary policy will normalize sooner than was anticipated, and with rising geopolitical tensions. Overall, the Bank projects global GDP growth to moderate from 6¾ % in 2021 to about 3½ % in 2022 and 2023.

In Canada, GDP growth in the second half of 2021 now looks to have been even stronger than expected. The economy entered 2022 with considerable momentum, and a broad set of measures are now indicating that economic slack is absorbed. With strong employment growth, the labour market has tightened significantly. Job vacancies are elevated, hiring intentions are strong, and wage gains are picking up. Elevated housing market activity continues to put upward pressure on house prices.

The Omicron variant is weighing on activity in the first quarter. While its economic impact will depend on how quickly this wave passes, it is expected to be less severe than previous waves. Economic growth is then expected to bounce back and remain robust over the projection horizon, led by consumer spending on services, and supported by strength in exports and business investment. After GDP growth of 4½ % in 2021, the Bank expects Canada’s economy to grow by 4% in 2022 and about 3½ % in 2023.

CPI inflation remains well above the target range and core measures of inflation have edged up since October. Persistent supply constraints are feeding through to a broader range of goods prices and, combined with higher food and energy prices, are expected to keep CPI inflation close to 5% in the first half of 2022. As supply shortages diminish, inflation is expected to decline reasonably quickly to about 3% by the end of this year and then gradually ease towards the target over the projection period. Near-term inflation expectations have moved up, but longer-run expectations remain anchored on the 2% target. The Bank will use its monetary policy tools to ensure that higher near-term inflation expectations do not become embedded in ongoing inflation.

While COVID-19 continues to affect economic activity unevenly across sectors, the Governing Council judges that overall slack in the economy is absorbed, thus satisfying the condition outlined in the Bank’s forward guidance on its policy interest rate. The Governing Council therefore decided to end its extraordinary commitment to hold its policy rate at the effective lower bound. Looking ahead, the Governing Council expects interest rates will need to increase, with the timing and pace of those increases guided by the Bank’s commitment to achieving the 2% inflation target.

The Bank will keep its holdings of Government of Canada bonds on its balance sheet roughly constant at least until it begins to raise the policy interest rate. At that time, the Governing Council will consider exiting the reinvestment phase and reducing the size of its balance sheet by allowing roll-off of maturing Government of Canada bonds."

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