Wednesday, July 14, 2021

Canada holds rate but trims asset purchases 2nd time

     Canada's central bank kept its key interest rate steady, as widely expected, but scaled back its asset purchases for the second time, saying this "reflects continued progress towards recovery and the Bank's increased confidence in the strength of the Canadian outlook."
     The Bank of Canada (BOC) left its target for the overnight rate at 0.25 percent, unchanged it was cut three times in March last year to what the bank considers the lower bound.
     In addition to the aggressive rate cuts - the rate was cut 1.50 percentage points - BOC also embarked on asset purchases, known as quantitative easing, of government bonds and commercial paper to keep longer-term interest rates low and keep financial markets operating smoothly.
     Initially BOC began buying C$5 billion of government securities a week and later expanded these purchases to include bonds from Canada's provinces and corporate bonds.
     But in October last year BOC shifted its weekly purchases toward longer-term bonds that had a more direct impact on borrowing costs and lowered the weekly amount to $4 billion.
     In April this year BOC became the first developed market central bank to begin the process of rolling back the extraordinary stimulus provided during the COVID-19 pandemic and cut the weekly purchase amount to $3 billion.
     Today, BOC trimmed its purchases further to $2 billion a week - the same day New Zealand's central bank decided to wrap up its asset purchases completely - and said further changes in the pace of bond purchases would depend on the strength and durability of the economic recovery.
     And while BOC raised its forecast for inflation this year and 2022, it lowered its forecast for growth this year as the third wave of the virus slowed growth in the second quarter.
     "The Governing Council judges that the Canadian economy still has considerable excess capacity, and that the recovery continues to require extraordinary monetary policy support," BOC said, confirming that it still expects to keep its policy interest rate at the current level until economic slack is absorbed so it sustainably reaches its 2.0 percent inflation target.
     As in April, when it last issued its economic forecast, it expects this to happen in the second half of 2022.
      In an update to its forecast, BOC sees gross domestic product growing 6.0 percent this year, down from the previous forecast of 6.5 percent, but then expanding by 4.6 percent in 2022, up from 3.7 percent previously forecast.
      Inflation in Canada has risen sharply in recent months and BOC now expects it to remain above 3.0 percent through the second half of this year before declining toward its 2.0 percent target in 2022 as short-run imbalances and economic slack pulls it lower.
     "The factors pushing up inflation are transitory, but their persistence and magnitude are uncertain and will be monitored closely," BOC said.
     Consumer price inflation rose to 3.6 percent in May from 3.4 percent in April and BOC expects the rate to average 3.0 percent this year, up from the previous forecast of 2.3 percent and 0.7 percent last year.
     In 2022 inflation is seen averaging 2.4 percent, up from 1.9 percent, and then 2.2 percent in 2023.
     The Canadian dollar, known as the loonie, has strengthened against the U.S. dollar since March last year through May this year but since the U.S. Federal Reserve's hawkish tilt in mid-June, it has lost ground, like most other currencies.
     Today, however, the loonie rose in response to BOC's tightening, with the loonie trading at 1.248 to the U.S. dollar to be up 2.2 percent since the start of this year.

         The Bank of Canada issued the following statement:

"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 is maintaining its extraordinary forward guidance on the path for the overnight rate. This is reinforced and supplemented by the Bank’s quantitative easing (QE) program, which is being adjusted to a target pace of $2 billion per week. This adjustment reflects continued progress towards recovery and the Bank’s increased confidence in the strength of the Canadian economic outlook.

The global economy is recovering strongly from the COVID-19 pandemic, with continued progress on vaccinations, particularly in advanced economies. However, the recovery is still highly uneven and remains dependent on the course of the virus. The recent spread of new COVID-19 variants is a growing concern, especially for regions where vaccinations rates remain low. 

Global GDP growth is expected to reach 7 percent this year and then moderate to about 4 ½ percent in 2022 and just over 3 percent in 2023. This a slightly stronger forecast than the one in the Bank’s April Monetary Policy Report (MPR) and primarily reflects a stronger US outlook. Global financial conditions remain highly accommodative. Rising demand is supporting higher oil prices, while non-energy commodity prices remain elevated. The Canada-US exchange rate is little changed since April.

In Canada, the third wave of the virus slowed growth in the second quarter. However, falling COVID-19 cases, progress on vaccinations and easing containment restrictions all point to a strong pickup in the second half of this year. The Bank now expects GDP growth of around 6 percent in 2021 – a little slower than was expected in April – but has revised up its 2022 forecast to 4 ½ percent and projects 3 ¼ percent growth in 2023.

Consumption is expected to lead the recovery as households return to more normal spending patterns, while housing market activity is projected to ease back from historical highs. Stronger international demand should underpin a solid recovery in exports. As domestic and foreign demand increases and confidence improves, business investment will gain strength. Employment has once again begun to rebound, and we expect the hardest-hit segments of the labour market to post strong gains as the economy re-opens. However, the pace of the recovery will vary among industries and workers, and it could take some time to hire workers with the right skills to fill jobs. The aftermath of lockdowns and ongoing structural changes in the economy both mean that estimates of potential output and when the output gap will close are particularly uncertain.

CPI inflation was 3.6 percent in May, boosted by temporary factors that include base-year effects and stronger gasoline prices, as well as pandemic-related bottlenecks as economies re-open. Core measures of inflation have also risen but by less than the CPI. In some high-contact services, demand is rebounding faster than supply, pushing up prices from low levels. Transitory supply constraints in shipping and value chain disruptions for semiconductors are also translating into higher prices for cars and some other goods. With higher gasoline prices and on-going supply bottlenecks, inflation is likely to remain above 3 percent through the second half of this year and ease back toward 2 percent in 2022, as short-run imbalances diminish and the considerable overall slack in the economy pulls inflation lower. The factors pushing up inflation are transitory, but their persistence and magnitude are uncertain and will be monitored closely.

The Governing Council judges that the Canadian economy still has considerable excess capacity, and that the recovery continues to require extraordinary 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 July projection, this happens sometime in the second half of 2022. The Bank's QE program continues to reinforce this commitment and keep interest rates low across the yield curve. Decisions regarding further adjustments to the pace of net bond purchases will be guided by Governing Council's ongoing assessment of the strength and durability of the recovery. We will continue to provide the appropriate degree of monetary policy stimulus to support the recovery and achieve the inflation objective."

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