It's a busy week on the policy front in Canada. In the wake of Monday's Federal budget, today saw a fresh interest rate announcement and updated Monetary Policy Report from the Bank of Canada. As expected, the Bank left its target interest rate unchanged, but it is now clearly warning markets that the gradual withdrawal of stimulus may start sooner than previously expected.
The tone of today's announcement, particularly as it relates to the growth outlook, is remarkably upbeat. In effect the Bank is admitting that its earlier caution about both the immediate economic outlook and prospects for growth in the medium term was too pessimistic. Here are some key quotes:
Global economic growth is stronger than was forecast in the January Monetary Policy Report .......After a contraction of 2 ½ percent in 2020, the Bank now projects global GDP to grow by just over 6 ¾ percent in 2021, about 4 percent in 2022, and almost 3 ½ percent in 2023. The recovery in the United States has been particularly strong, owing to fiscal stimulus and rapid vaccine rollouts. The global recovery has lifted commodity prices, including oil, contributing to the strength of the Canadian dollar.
In Canada, growth in the first quarter appears considerably stronger than the Bank’s January forecast, as households and companies adapted to the second wave and associated restrictions....... As vaccines roll out and the economy reopens, consumption is expected to rebound strongly in the second half of this year and remain robust over the projection.,,,,,,The Bank will continue to monitor the potential risks associated with the rapid rise in house prices. Meanwhile, strong growth in foreign demand and higher commodity prices are expected to drive a robust recovery in exports and business investment. Additional federal and provincial fiscal stimulus will contribute importantly to growth. The Bank now forecasts real GDP growth of 6 ½ percent in 2021, moderating to around 3 ¾ percent in 2022 and 3 ¼ percent in 2023.
The Bank has revised its estimate of potential GDP growth to the upside, which may give it latitude to keep monetary stimulus in place for a longer period. However, it still expects CPI to move to the top of the 1-3 percent target band in the near term, mainly because of base effects:
Over the next few months, inflation is expected to rise temporarily to around the top of the 1-3 percent inflation-control range. This is largely the result of base-year effects—year-over-year CPI inflation is higher because prices of some goods and services fell sharply at the start of the pandemic. In addition, the increase in oil prices since December has driven gasoline prices above their pre-pandemic levels. The Bank expects CPI inflation to ease back toward 2 percent over the second half of 2021 as these base-year effects diminish, and inflation is expected to ease further because of the ongoing drag from excess capacity. As slack is absorbed, inflation should return to 2 per cent on a sustained basis some time in the second half of 2022.
As if to illustrate these points, this morning Statistics Canada published its report on consumer prices for March. Headline CPI (not seasonally adjusted) rose 0.5 percent in the month, but a powerful base effect meant that the year-on-year rise leapt to 2.2 percent from 1.1 percent in February. The Bank of Canada will argue that it can "look through" this spike, since CPI ex energy rose only 1.1 percent year-on-year. However, it may be noted that two of its three "preferred" measures of core inflation moved above 2 percent in the month. If that were to continue, the market jitters that have been pushing bond yields higher in recent weeks might intensify.
The Bank continues to believe that the economy requires extraordinary support from monetary policy, and is committed to providing such support until it sees inflation sustainably at the 2 percent midpoint of the target range. However, it is now suggesting that this may happen as soon as the second half of 2022, rather than in 2023 as it previously predicted. This implies that the gradual tightening cycle may begin around that time. In addition, the Bank is moving immediately to reduce its weekly purchase of Government bonds under its quantitative easing program to C$ 3 billion from the present level of C$ 4 billion. All in all, today's announcement is a subtle but important change in the Bank's messaging.
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