Dire straits

The flow of bad economic news created by the COVID-19 pandemic is turning into a torrent. Employment indicators in both the United States and Canada responded shockingly fast to the virtual shutdown of the two economies in mid-March.  This week has seen further evidence of damage south of the border, as retail sales, industrial production and sentiment all plummet.

Here in Canada, Statistics Canada has taken the unprecedented step of compiling a "flash estimate" for GDP for the month of March.  It does not make for good reading.  StatsCan estimates that real GDP fell by 9 percent in the month,  which implies a fall in GDP of 2.6 percent (or more than 10 percent on an annualized basis) for the first quarter as a whole. It probably goes without saying that this is by far the fastest rate of decline seen since the monthly GDP series began in 1961.  In case the raw data are not dispiriting enough, it needs to be borne in mind that the effective lockdown of  "non-essential" sectors of the economy by the Federal and Provincial governments only took place in the middle of March. 

So, what's next?  Today was a scheduled rate announcement day for the Bank of Canada, as well as the release date for an updated Monetary Policy Report (MPR).  Having cut rates three times already in response to the crisis, the Bank kept its key rate unchanged at 0.25 percent today, as markets had expected, and signalled very clearly its reluctance to move rates into negative territory. However, it announced further measures to inject liquidity into markets in order to keep the financial system functioning smoothly: it will now be buying Provincial and corporate bonds in the secondary market, in addition to the previously announced program of federal bond purchases.

In terms of the economic outlook, the Bank is predictably downbeat. It expects that economic activity for the second quarter of the year will be anywhere from 15 to 30 percent lower than it was at the end of 2019. That is an unusually broad range that encompasses two widely differing outcomes.  The less pessimistic end of the range implies in a sense that March will come to be seen as the worst phase of the crisis, with declines during the second quarter itself taking place at a slower pace. By contrast the more pessimistic estimate sees the pace of decline continuing close to the March rate for at least the next two months or more.

Considering the problems in the real economy right now, it is perhaps surprising that much of the press release for the MPR focuses on the inflation outlook. It turns out, however, that this gives the opportunity to put the impact of the crisis and the policy response into better perspective.  The Bank acknowledges that the near-term outlook has taken a deflationary turn, but does not believe that persistent price weakness will become an issue. Here is the relevant paragraph in full:

Fortunately, the risk of sustained deflation in Canada is low, for several reasons. First, there has been a vigorous and elastic response from governments to the pandemic. These actions will put a floor under the economy and lay the foundation for the subsequent recovery. This is especially true for wage subsidies, which are designed to maintain the employee-employer relationship, thereby buttressing confidence and facilitating the recovery. Second, Canada began the pandemic episode with the economy operating near potential and inflation around its 2 percent target. Just as a healthy, fit individual is more likely to shake off a COVID-19 infection, a healthy economy is more likely to recover quickly from a major negative shock. Third, Canada has enjoyed considerable success in keeping inflation close to target for more than 25 years. This means that investors, firms and households expect that the Bank will act to help return the economy to capacity and bring about stable, 2 percent inflation. The Bank’s recent actions should be seen in exactly that light.

The Bank's next scheduled policy statement date is June 3, though in current circumstances the need for earlier action cannot be ruled out. Just one day earlier, on June 2, Governor Stephen Poloz's term is set to end.  No replacement has yet been announced, though the smart money must be on Senior Deputy Governor Carolyn Wilkins.  There have been reports from Ottawa that Poloz has offered to stay on for a brief time, but that it is unlikely that the government will take him up on this. As someone who offered plenty of criticism of Poloz in his early days on the job, I am happy to admit that as he nears the end of his term he has proved me wrong. We can only hope that his successor can hit the ground running, amid the worst economic crisis in living memory.