Wednesday 20 January 2021

Bank of Canada: no change

Amid all the coverage of Donald Trump's departure from Washington and Joe Biden's inauguration as President, it would have been easy to miss a couple of pieces of economic news from Canada today. Let's rectify that. 

Ahead of today's Bank of Canada Governing Council meeting there had been some speculation that the Bank might announce a "micro" rate cut from the current level of 25 basis points. This frankly would have been almost pointless, and in the event the Bank chose to leave its rate settings unchanged and to maintain its quantitative easing program at the current pace of C$ 4 billion per month. 

The Bank's economic outlook, spelled out in more detail in the quarterly Monetary Policy Report, has become rather more optimistic since the previous such Report appeared back in October. The Bank acknowledges that the strong second wave of COVID has set back the economic recovery here in Canada and around the world, and it expects GDP to contract during the current quarter. However, it is optimistic about the likely impact of the rollout of vaccines: it expects that the current tight restrictions will be eased by the end of Q1, giving rise to a solid rebound in the second quarter of the year.

The Bank may have been blindsided by recent events here. Canada's vaccine deployment has been pitifully slow, and we just learned that deliveries of the Pfizer vaccine, one of two approved for use here, will fall to zero next week and only get back to previously predicted levels by the end of February. This is likely to mean that easing of pandemic restrictions will not be possible until some time in March, which implies that the rebound in Q2 will be smaller than the Bank is expecting.

The Bank's forecast looks for GDP growth of 4 percent in 2021, after last year's estimated 5.5 percent drop. Growth is expected to reach 5 percent in 2022, which would appear to imply that real GDP will be back at its pre-pandemic level by about the middle of that year. The current problems with vaccines may mean that full recovery of the economy will take a little longer than the Bank is expecting.

As for inflation, the Bank notes that headline CPI has been at the bottom of the desired 1-3 percent range in recent months, with core measures below the 2 percent target level. It expects headline CPI to head towards 2 percent in the coming months as base effects (mainly relating to gasoline prices) fall out of the calculation. However, it does not expect that uptick to persist; it still does not foresee inflation moving sustainably above 2 percent until 2023, and it continues to pledge to keep rates unchanged until that time. 

As it happens, today also saw Statistics Canada release its CPI report for December. Headline CPI rose 0.7 percent in the month, down from 1.0 percent in November, with weakness evident in airfares and food prices. Excluding gasoline, CPI rose 1.0 percent in December, down from 1.3 percent in November. In line with the Bank of Canada's statement, all three of the preferred measures of core inflation stand below the 2 percent target. However, it is noticeable that the dispersion between these measures is much wider than it usually was in pre-pandemic days, which raises doubts about their usefulness for the Bank as it makes its policy decisions. 

The Bank of Canada's position that rates will stay on hold until 2023 is almost universally accepted in markets, but there are exceptions. Here is one article that suggests that a revival in growth and strong international commodity prices will make the Bank one of the first among major economies to move to tighten policy, perhaps even before 2023. Right now that looks improbable, especially as higher commodity prices would surely strengthen the exchange rate, which would weigh on GDP growth. It would be surprising if the Bank chose to compound that by also raising rates, unless inflation shows signs of coming back much more rapidly than is currently expected. 

 

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