What happened: The Bank of Canada further slowed its quantitative easing program, reducing emergency stimulus as the economic outlook improves – reinforcing its position as one of the most hawkish central banks in the G7. Policymakers lowered the asset purchase target from $3 billion to $2 billion a week, saying, “the adjustment reflects continued progress towards recovery and the Bank’s increased confidence in the strength of the Canadian economic outlook”.
This reduction was well-telegraphed: Ahead of the meeting, markets overwhelmingly expected a $1 billion reduction in asset purchases, motivating traders to take profits on confirmation. The Canadian dollar weakened slightly on the release.
The external outlook has improved: Policymakers raised global growth projections to 7 percent this year, followed by 4.5 percent in 2022, and 3 percent in 2023. According to the statement, “This a slightly stronger forecast than the one in the Bank’s April Monetary Policy Report (MPR) and primarily reflects a stronger US outlook. Global financial conditions remain highly accommodative. Rising demand is supporting higher oil prices, while non-energy commodity prices remain elevated”.
The exchange rate has round-tripped: Despite considerable volatility in the interim, the dollar-Canada exchange rate is sitting very close to the levels that prevailed when the Bank met in April.
Vaccination rates are near the top of global league tables: More than 50 percent of Canadian adults have been fully vaccinated, and case counts are plummeting across the country. Business sentiment levels have soared in synchrony.
Employment is widely expected to hit pre-pandemic levels within months: Economists surveyed by several major data providers are projecting a full recovery by October, with hiring picking up in the coming months.
Fiscal stimulus continues to flow: Consumers continue to benefit from Canadian government largesse, and lagged spillover effects from US efforts are helping to lift export expectations.
Domestic growth expectations are less front-loaded: “The Bank now expects GDP (gross domestic product) growth of around 6 percent in 2021 – a little slower than was expected in April – but has revised up its 2022 forecast to 4 ½ percent and projects 3 ¼ percent growth in 2023”.
Inflation is running persistently above target: Prices are projected to rise more than 3 percent this year before easing back toward 2 percent in 2022 – yet risks are skewed to the upside: “The factors pushing up inflation are transitory, but their persistence and magnitude are uncertain and will be monitored closely”.
Tightening was already underway: The Bank has amassed some $380 billion in assets since the beginning of the pandemic, and currently holds more than 45 percent of all outstanding Government of Canada bonds. But its balance sheet has shrunk slightly since mid-March, falling from $575 billion to $484 billion as buying activity has slowed and existing holdings have matured.
More tightening is expected: Markets expect asset purchases to fall toward zero by year end, and overnight index swaps show one rate hike is priced in over the next 12 months, with three more to follow within 24 months. This puts the implied policy rate at 1.21 percent in two years, relative to 0.59 percent in the United States – a yield difference sufficient to keep the Canadian dollar well supported.
But: Canadian households have accumulated spectacular amounts of debt – slowing credit growth and rising yields could slow consumption and weaken the economy in the years to come. Today’s extraordinarily-wide rate differentials could come under pressure if “debt trap” concerns reappear.
Karl Schamotta – Chief Market Strategist, firstname.lastname@example.org
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