Bank of Canada: tightening? Don't even think about it!

Bond yields around the world have been rising as investors fret about the possibility that economic recovery and massive monetary stimulus will trigger a surge in inflation.  Here in Canada the benchmark 10-year yield, which started the year below 0.7 percent, has topped 1.5 percent in recent days.  The rise in market rates has spilled over into banks' mortgage rates, which have started to move up from rock-bottom levels.

Against this background, the Bank of Canada today issued its latest interest rate decision. As expected, it left its key target rate unchanged at 0.25 percent and committed to maintaining its quantitative easing program at current levels for the foreseeable future. The press release issued with the decision made it quite clear that the Bank still does not expect to start raising rates until 2023. 

The Bank acknowledges that the economy is proving more resilient than expected in the face of the second wave of the COVID pandemic. At the time of its last rate announcement in January, it expected GDP to decline in the current quarter, but it now expects positive growth. Nevertheless, it still sees both considerable uncertainty, mainly over the risk posed by COVID variants, and economic slack, particularly in some segments of the labour market. 

Inflation is likely to be tricky for the Bank in the very near term, at least in terms of optics. Headline CPI is near the bottom of the 1-3 percent target range. However, the "base effect" as extremely low monthly readings at the height of the first wave last year fall out of the computation will push it near the top of the range towards mid-year. The Bank is confident that persistent economic slack will then force inflation lower again; it will be interesting to see if markets and the media share that confidence as the numbers start to move higher in the next month or two.

The final paragraph of the release is an unequivocal restatement of the Bank's continuing commitment to easy policy, but there is one small hint of how it will eventually start to remove stimulus:

While economic prospects have improved, the Governing Council judges 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 January projection, this does not happen until into 2023. To reinforce this commitment and keep interest rates low across the yield curve, the Bank will continue its QE program until the recovery is well underway.  As the Governing Council continues to gain confidence in the strength of the recovery, the pace of net purchases of Government of Canada bonds will be adjusted as required. We will continue to provide the appropriate degree of monetary policy stimulus to support the recovery and achieve the inflation objective.

That penultimate sentence indicates that the first step the Bank will take towards tightening will be to scale back its monthly QE program. That's something for markets to look out for; it will be interesting to see if the Bank offers any kind of a heads-up before actually taking this very significant step. On the basis of today's announcement, however, any move of this sort is still many months away.