Bank of Canada sits tight

With election day less than two weeks away, there was little likelihood that the Bank of Canada would make any policy changes at today's Governing Council meeting. And so it proved: the Bank kept its target rate unchanged at 0.25 percent and committed to maintain its quantitative easing program at the current pace of C$ 2 billion per week. 

Most of the Bank's press release was devoted to explaining why both growth and inflation have deviated from earlier expectations, and why those deviations do not signal any need for policy adjustments.

As regards growth, the Bank blames the unexpected fall in Canada's GDP in the second quarter (and in July) on global supply chain issues. The GDP decline was concentrated in the export sector,  with autos particularly hard-hit.  Aside from that weakness and some pullback in housing, the Bank paints a relatively rosy picture of current and future growth:

Consumption, business investment and government spending all contributed positively to growth, with domestic demand growing at more than 3 percent. Employment rebounded through June and July, with hard-to-distance sectors hiring as public health restrictions eased. This is reducing unevenness in the labour market, although considerable slack remains and some groups – particularly low-wage workers – are still disproportionately affected. The Bank continues to expect the economy to strengthen in the second half of 2021, although the fourth wave of COVID-19 infections and ongoing supply bottlenecks could weigh on the recovery.

In terms of inflation, the Bank's stance is almost identical to the Fed's: yes, inflation is well above target now, but only for transitory reasons:

CPI inflation remains above 3 percent as expected, boosted by base-year effects, gasoline prices, and pandemic-related supply bottlenecks. These factors pushing up inflation are expected to be transitory, but their persistence and magnitude are uncertain and will be monitored closely. Wage increases have been moderate to date, and medium-term inflation expectations remain well-anchored. Core measures of inflation have risen, but by less than the CPI.

As regards that final sentence, it should be noted that while core measures of inflation are indeed below headline CPI, they have moved steadily above the 2 percent target in recent months, something the Bank cannot simply ignore. 

Given the Bank's views on growth and inflation, its decision to stand pat is no surprise. It will continue its QE program and still does not expect to raise rates until late next year:

Governing Council judges that the Canadian economy still has considerable excess capacity, and 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 July projection, this happens in the second half of 2022.... We will continue to provide the appropriate degree of monetary policy stimulus to support the recovery and achieve the inflation objective.

There is a small risk that the ongoing pandemic will require even more support, but the economy's resilience has increased greatly as each wave of COVID has unfolded. The bigger risk, for the Bank no less than the Fed, is that inflation proves stickier than expected, which could force the Bank's hand if it wishes to maintain the credibility of its inflation target.