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Bank of Canada Marks Time Ahead of October Decision

by Karl Schamotta | September 8, 2021

In the statement accompanying its latest decision, the Bank of Canada remained stubbornly hawkish, acknowledging slowing economic momentum, while retaining a firmly optimistic view on the longer-term outlook. With the next Monetary Policy Report scheduled to land in late October, the Bank reverted to its July projections, suggesting that economic slack will disappear – and rate increases could begin – in the second half of 2022.

Policy settings were left unmoved: Central bankers kept interest rates and quantitative easing volumes unchanged, saying that the benchmark policy rate would remain near the lower bound until the 2 percent inflation target is “sustainably achieved”.

Officials acknowledged recent economic weakness, but pinned much of the blame on supply chains: The statement said “GDP contracted by about 1 percent in the second quarter, weaker than anticipated in the Bank’s July Monetary Policy Report,” but “This largely reflects a contraction in exports, due in part to supply chain disruptions, especially in the auto sector”.  Housing market activity slowed, yet this unfolded “largely as expected”.

Last week, Canada’s national statistics agency said the economy contracted -1.1 percent in the second quarter, with weakness expected to continue into July. 

Employment gains were noted: According to the statement, job growth “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”. According to our calculations, Canada’s labour market remains roughly 450,000 positions smaller than the Bank’s pre-pandemic trend level estimate.

The Bank continued to look through elevated inflation rates: Price gains that have been “boosted by base-year effects, gasoline prices, and pandemic-related supply bottlenecks” are expected to be “transitory”. A much-feared “wage price spiral” looked unlikely, as salary increases stay low and “medium-term inflation expectations remain well-anchored”.

The loonie round-tripped in response: The Bank’s “hawkish hold” briefly put a tailwind behind the Canadian dollar, but this was erased as the greenback moved higher against all its major rivals.

Bottom line: The Bank of Canada remains one of the most hawkish central banks in the Group of Seven. Markets expect asset purchases to move into neutral by early next year, with three rate hikes coming by the end of 2023. This should help the loonie remain well supported ahead of the October rate decision – but the path there is strewn with risks, from the upcoming federal election to the US debt ceiling debate. Volatility is likely to ratchet higher from the lows reached in mid-August.

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