Bank of Canada: not much to see here

As expected, the Bank of Canada kept its interest rate target unchanged at 0.25 percent today. It also maintained its quantitative easing (QE) program at the current pace of C$ 3 billion per week. The Bank remains "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 April projection, this happens sometime in the second half of 2022".

Despite today's decision, much of the media release could be read as a case for a much earlier tightening move. Indeed my own former shop on Bay Street, TD Economics, apparently believes a rate hike could come sooner than the Bank expects, if there is an "explosion" in growth.  Consider these excerpts from the media release: 

Regarding growth: after acknowledging that Q1 GDP growth fell short of the Bank's expectations, the release goes on to state that "With vaccinations proceeding at a faster pace, and provincial containment restrictions on an easing path over the summer, the Canadian economy is expected to rebound strongly, led by consumer spending. Housing market activity is expected to moderate but remain elevated. Strong growth in foreign demand and higher commodity prices should also lead to a solid recovery in exports and business investment."

Regarding inflation: "the risks to the inflation outlook identified in the April MPR remain relevant....As expected, CPI inflation has risen to around the top of the 1-3 percent inflation-control range, due largely to base-year effects and much stronger gasoline prices. Core measures of inflation have also risen, due primarily to temporary factors and base year effects, but by much less than CPI inflation. While CPI inflation will likely remain near 3 percent through the summer, it is expected to ease later in the year, as base-year effects diminish and excess capacity continues to exert downward pressure."

This growth and inflation outlook hardly seems to support the Bank's intention to stay on the sidelines for another year. A growth spurt in the second half of 2021 seems all but locked in, given the accelerated vaccine rollout and the strong recovery in the US economy. As for inflation, the Bank's complacency looks very much open to challenge.  It is true that much of the recent uptick in headline CPI is related to base effects, but shortages of a wide variety of goods, from lumber to microchips, do not suggest that underlying cost pressures will ease any time soon. The Bank may be comfortable with inflation at the top of its target range over the next few months; financial markets may not feel the same way. 

The Bank justifies its stance in a single sentence:   "The Governing Council judges that there remains considerable excess capacity in the Canadian economy, and that the recovery continues to require extraordinary monetary policy support." The current unemployment rate certainly attests to the presence of slack in the economy, but a large proportion of reported unemployment represents the temporary loss of part-time jobs in sectors hardest hit by COVID restrictions. Those jobs will quickly reappear as restrictions lift in the coming weeks. 

In the meantime, monetary policy is only one element of the "extraordinary" policy support being showered on the economy right now, with the Federal government adding further fiscal stimulus. The Bank's unworried attitude towards inflation may prove correct in the end, but there is little doubt that the risks to its base case are all tilted in one direction.