BOC sees recovery as on track, stays course
Officials shrug off GDP wobble while maintaining rate, Kevin Carmichael writes.
The Bank of Canada said the recovery remains on track, an expression of faith in the economy that suggests policy-makers could further reduce their purchases of federal bonds as early as next month.
As expected, governor Tiff Macklem and his deputies opted to leave the current level of stimulus unchanged at the end of their latest round of interest-rate deliberations on Wednesday. The election raised the bar for a shift in policy, as Macklem would only risk becoming a campaign issue if economic conditions demanded it. They didn't, allowing the governor to turn the central bank's latest interest-rate decision into a non-event.
The message from Canada's central bankers was that “even though the recovery lost a bit of steam in the second quarter, the ingredients are there for economic activity to strengthen through the remainder of the year,” Sri Thanabalasingam, an economist at Toronto-dominion Bank, said in a note to clients. “While the Delta variant could complicate matters, the bank, like us, do not expect the virus to blow the recovery off course in the fourth quarter.”
The Bank of Canada kept the benchmark borrowing rate at 0.25 per cent, reiterating that it intends to leave it there until at least the second half of next year. Policy-makers also re-upped their pledge to buy roughly $2-billion worth of Government of Canada bonds every week, a commitment that was lowered from $3 billion at the end of the previous round of policy deliberations in July.
“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,” officials said in their updated policy statement.
Their confidence in the recovery might surprise some people. Gross domestic product (GDP) contracted at an annual rate of
1.1 per cent in the second quarter, while policy-makers had been anticipating growth of about two per cent. It was a notable miss.
But the Bank of Canada's leaders mostly shrugged it off, saying the recovery continues to roughly unfold as they assumed it would when they last updated their outlook in July. The Bank of Canada predicted then that GDP would grow six per cent in 2021 and 4.6 per cent in 2022 after contracting by more than five per cent last year.
Forecasting during the pandemic has been difficult because models based on history are ill-equipped to deal with a truly unique global calamity. Sometimes, the surprises have been positive. The Bank of Canada had assumed in January that the third wave of COVID-19 infections would cause the economy to contract in the first quarter, and instead it grew at an annual rate of 5.5 per cent. To a certain extent, the recovery is ahead of where the central bank thought it would be at the end of last year.
Macklem and the rest of the Governing Council appear to think that the GDP report was better than it looked on the surface. They said the decline was “largely” the result of a drop in exports, which have since picked up. International shipments of goods increased 7.5 per cent in June from May, and then rose an additional 0.6 per cent in July, Statistics Canada reported on Sept. 2.
Apart from a wobble in trade, the GDP numbers indicated the recovery had momentum heading into the summer. The central bank noted that consumption, business investment and government spending all were positive and there is little reason to think any of those engines will begin to sputter.
“We thought the bank would emphasize downside risks to its July projections, but today's policy statement provided a more balanced assessment of economic conditions than we anticipated,” Josh Nye, an economist at Royal Bank of Canada, said.
There is little conviction among the closest observers of the Bank of Canada about when Macklem will next taper the bond-purchase program. Nye said there's a risk that policymakers could pause again at the end of October when they next meet to consider their stimulus program. At the same time, Karl Schamotta, chief market strategist at Cambridge Global Payments, said the Bank of Canada “remains one of the most hawkish central banks in the Group of Seven,” an interpretation that implies Macklem and his colleagues are leaning towards ending the bond purchases as soon as economic conditions allow.
To the extent that the Bank of Canada has offered a path, it has only said that the decision will be based on evidence that the recovery continues to strengthen.
The next important indicator will come on Friday when Statistics Canada publishes its next batch of hiring numbers. The central bank noted in its statement that hiring rebounded in June and July, “reducing unevenness in the labour market.”
Macklem has repeatedly said this year that he is looking for a “complete” recovery that returns employment levels to what they would have reached if not for the crisis. All things equal, that argues for extending bond purchases. The statement observes that “some groups,” especially low-wage workers, “are still disproportionately affected” by the COVID-19 crisis.
Still, he has to keep an eye on inflation, which surged 3.7 per cent in July from a year earlier, matching the largest increase since 2011. The Bank of Canada's target is two per cent.
The Bank of Canada said inflation is being influenced by comparisons with a year ago, when the economy was struggling, and there was a surge in gasoline prices and supply bottlenecks.
All are factors that should fade with time. The trouble is that policy-makers don't seem to have a handle on how long that could take.
“These factors pushing up inflation are expected to be transitory, but their persistence and magnitude are uncertain and will be monitored closely,” their policy statement said.