BoC holds rate steady, focuses on economic growth
The Bank of Canada plans to let inflation run faster than its two-per-cent target through 2023, reinforcing governor Tiff Macklem's pledge to orchestrate a “complete” recovery from the COVID -19 recession.
Canada's central bank on Wednesday published new forecasts predicting the country is on the verge of an impressive burst of economic growth that will offset a disappointing start to the year. The projections weren't strong enough to alter Macklem's plan to keep the benchmark interest rate pinned near zero until at least the second half of next year, but evidence of gathering momentum prompted policy-makers to pare their weekly purchases of Government of Canada bonds to $2 billion, from $3 billion previously.
“This adjustment reflects continued progress towards recovery and the bank's increased confidence in the strength of the Canadian economic outlook,” Macklem and his deputies on the Governing Council said in a statement at the end of their latest round of interest-rate deliberations. The decision to taper the bond-buying program was widely expected by observers of the central bank, as was an upward revision to growth projections for the second half of the year and 2022.
The short-term trajectory of the economy is correlated with vaccination rates and infections; the former in Canada are now among the world's highest, and provinces have mostly relaxed the social-distancing measures they implemented to fight COVID-19'S third wave this spring.
Macklem's forecasting team sees growth surging to an annual rate of 7.3 per cent in the third quarter, compared with two per cent between April and June, as consumers begin to spend some of the savings they accumulated during COVID-19 lockdowns.
The new prediction represents a shift in the central bank's thinking about the recovery. Previously, officials assumed Canadians would keep whatever cash they accumulated during the pandemic in the bank. Now, they assume that we'll spend about 20 per cent of that hoard, citing survey data that show households are keen to celebrate the pandemic's end.
“Consumption is expected to continue to lead the recovery,” Macklem said in a statement about the Bank of Canada's policy meeting and the new outlook.
The third wave of infections took a bigger toll on the economy than policy-makers thought it would at the time of their last forecast in April, forcing a downward revision of its outlook for economic growth this year to six per cent, from 6.5 per cent. But it assumes the economy will make up for it next year, when the central bank predicts gross domestic product will increase 4.6 per cent, compared with a previous estimate of 3.7 per cent.
Still, the good news related to an accelerating recovery could be partially offset by consternation over the inflation forecast, since it shows the central bank has chosen to put employment ahead of its target for annual increases in the Consumer Price Index.
The Bank of Canada's two-year forecasts almost always have the CPI at two per cent at the end of the projection period, because, typically, interest rates would be adjusted to bring about that outcome. For now, the central bank predicts CPI inflation of three per cent this year, 2.4 per cent in 2022 and 2.2 per cent in 2023.
The strategy is risky because households, executives and investors could start to assume the central bank has gone soft on inflation and adjust their own expectations accordingly. If that were to happen on a wide scale, upward pressure on prices would increase, pushing the CPI even higher. The central bank might have to raise interest rates more quickly than it would like, threatening a recession.
Policy-makers argued that they're taking a calculated risk — and one worth taking. Investors and analysts tend to emphasize the inflation target, but the Bank of Canada actually gives itself more latitude than many believe. It aims for two per cent, but is comfortable with misses as high as three per cent and as low as one per cent. It still sees inflation staying within that comfort zone.
“I don't know if they are going soft” on inflation, said Tom O'gorman, director of fixed income at Franklin Templeton Canada. “For inflation to run a little hot with the pandemic and the supply-chain issues, it's probably appropriate.”
Ultimately, Macklem has chosen to err on the side of growth rather than striving to hit his inflation bullseye. The central bank noted that the economy is generating significantly less output than it could in normal circumstances, and, when considering population growth, employment is still 550,000 positions below its pre-pandemic trajectory.
“We have one target, and that's inflation,” he told reporters. “If we have excess slack in the economy, that means we're missing jobs, we're missing income, we're missing spending. That will put downward pressure on inflation and we won't sustainably achieve our inflation target.”